The Great Financial Crisis was a lesson in collateral. Most focus upon the subprime since, after all that is what Ben Bernanke talked about. However, when we delve into what went on globally, within the banking world, we see that it was a collateral crisis.
At the core of this was mortgage backed securities (MBS). If we will recall, the rating agencies had these classified on par with U.S. Treasuries. This was a major problem because, as it turned out, much of it was junk.
Why do I bring this up? The answer is rather simple. The world has not recovered from that even. In the realm I am discussing, money is anything that is liquid and tradeable. With digitization, things were radically altered. Unfortunately, with so much collateral going off the table, we are suffering from a major deficit. This is echoing throughout the entire global economy.
This is a problem that cryptocurrency can solve. Since there are limited to fractional reserve banking as the currency creation mechanism, mainly that banks will not lend when times are bad, we see how an alternative is needed.
In this article we will discuss how cryptocurrency can seek to fill it. This is done by the establishment of a DeFi system that operates outside the central bank and government system.
Collateralized Lending
This is at the core of global trade. Most do not realize but the Eurodollar system, with its many parts, is responsible for funding roughly 90% of global trade. This is a fairly significant number. When that system breaks down, which is precisely what happened since the Great Financial Crisis, we see how things get very messy. Ultimately, this impacts global growth, causing economies to slow.
Decentralized Finance (DeFi) can certainly be a solution. Here we see the ability to utilize anything that is liquid and tradeable for these purposes. Collateral quality, when used in the short term, is dependent upon liquidity. The credit worthiness of the issuing entity means nothing. Can I get my money by selling when the markets open this if there is default?
Of course, things take on a different connotation when collateralizing longer term lending. Here we see volatility enter the picture. This is why the Hive Backed Dollar (HBD) has something to offer.
Much of DeFi lending, up to this point, revolved around an asset such as Ethereum. When using a coin of this nature, we encounter some issues. For example, MakerDAO was based upon the idea of collateralizing enough to ensure the threshold was always met. If the price of ETH dropped 75%, with a 50% barrier, the collateral was either liquidated or more was required. This is what Michael Saylor likely encountered with his loans against Bitcoin.
The problem is a collateral call can sink a firm or individual. This is what truly did Bear Stearns in. JP Morgan, the custodian for the Repo Market at the time, put a $5 billion call on Bear, knowing full well the bank did not have it.
When it comes to collateralized lending, volatility can wipe out the entire transaction. This is one of the reasons why stocks are not commonly used in this manner. They simply are too volatile.
HBD As A Solution
At present, HBD can be placed in savings on the blockchain, eliminating counterparty risk. It pays a yield of 20%, with unlimited duration. I proposed the addition of time vaults to the blockchain, which would then require specific lock up periods, say 1 year. Hence, we would then have an asset that has a stated return for a period of time with the transparency of knowing what timeframe is covered. Thus, each day, the present value of the assets, based upon the return, could be determined.
Here is where the collateral aspect can enter. Much of this was outlined in Hive Bonds: The Collateral The World Needs. Effectively, we are looking at a token being created to represent this HBD in time vault. This would allow for the token to be traded on a market. Similar to bonds, over time, we could see the liquidity grow.
When it comes to lending, we can see how this is much better option than using a value capture coin like ETH. The reason why U.S. T-bills are considered pristine collateral is because, in addition to being always on-the-run (liquid), maturity is only a few weeks out. Even if one had to hold, redemption for the full par amount is within site.
Hive bonds (tokens) could be set up the same way. This could offer a short-term lending platform that reduces the risk associated with volatility. Under a system like MakerDAO, we are looking something akin to margin trading with equities. Again, this is not a sensible way to collateralize.
The Numbers Get Ridiculous
When most think of lending, they conjure up images of a mortgage or car loans. Certainly, this is what most of us engage upon. In this arena, especially with mortgages, the numbers can get rather large.
However, it is vital to know this is a drop in the bucket.
When it comes to short-term lending, the numbers get mind-blowing. The repo market trades $4T-$5T daily. That is only what goes through the custodian. The bilateral, non-reported agreements between banks and other financial institutions is anyone's guess. Those are effectively peer-to-peer, with no way of knowing exactly how much is done. Some estimate the numbers double to the total.
Simple math tells us we are dealing with $8T-$10T in transactions each day. Repo agreements are really nothing more than collateralized loans.
Bitcoin is noted in the cryptocurrency world for its liquidity. The leading coin trades roughly $40 billion each day. This is not an inconsequential amount. When looking at the market we are referring to here, the ability to conduct $10B or $25B transactions is necessary. This is not total but single trades.
What This Does For Hive
Consider the implementation of a system like this, to whatever degree is achievable.
Since HBD is backed by $HIVE, the "reserve" is effectively the market cap, subject to the haircut rule. Hence, the conversion mechanism alters the supply of each coin. In this way, they are contingent upon each other, at least to some degree.
To handle even $5 billion in transactions of this nature would require, due to the haircut rule, $HIVE having a market cap of just shy of $17 billion. This does not include anything associated with the ecosystem or the fact that HBD is used for other purposes. We are only referring to short-term lending through the collateralization of a token produced by staking a stablecoin.
Commerce is obviously important for a currency. However, as we can see, the financial arena is much bigger. The numbers can get truly insane in a short period of time.
Delving into this realm, we see the ability to:
- eliminate counterparty risk
- allow the market to utilize monetary elasticity
- create a market of liquidity and open trading
- offer full transparency since all transactions are tied to the blockchain
There are large segments of the existing financial system that are inefficient and suffering. These are primed to be disrupted by cryptocurrency. Unfortunately, the route many are taking is by constructing a system that is riddled with risks that need not be taken. Here we see why terms like elasticity, volatility, and tradability are important.
Something like this could be developed on Hive. It is one of the few chains that has the technical ability to do so.
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