There are many problems with the traditional financial system. A large part of these could be isolated to the fact that fragility is implemented due to a practice known as rehypothecation. This is something that few pay attention to. It also crept into the cryptocurrency industry.
When looking at the existing financial system, now called TradFi, we see how things can turn wrong in a quick period of time. When financial institutions leverage assets, it can become the proverbial house of cards. Decentralized Finance (DeFi) offers a solution to this if constructed properly.
Unfortunately, much of what we saw within the cryptocurrency world was nothing more than a repeat of what Wall Street firms do. This caused some major problems which resulted in the implosion of many companies. The fallout from this is still being felt by the industry.
In this article we will look at what is being done and how Hive Bonds can potentially change this.
Rehypothecation
What is rehypothecation?
Before getting to that, it might be best to explain what hypothecation is? This is the process where one puts up an asset for a loan that has an interest rate tied to it. We see this with mortgages. A house is used a collateral against the outstanding balance on the loan.
This can always occur in other financial transactions as we will see in a moment. The key point is that we are dealing with two parties: the borrower and lender. While this can be facilitated by a third party, in the end, there are two individuals or entities involved.
Rehypothecation goes one step further. This is when a financial institution takes the asset pledged and use it as collateral in another deal. The result is called a "collateral string". Here we see the same asset pledged a number of time.
As we can see, there are no longer two parties involved, We now have another set of players entering. When things go bad, it is easy to envision what happens. The fine print becomes very important because one agrees to return the collateral "if available".
We saw this within the cryptocurrency realm. The staking of assets became popular. Unfortunately, as people found out, counterparty risk is something that should have been looked at.
What we saw was people staking coins, such as Bitcoin. This was done to garner a return, or yield. The interest rate was promised which attracted the investors. If the story ended here, no problem.
Here is where rehypothecation enters. The Bitcoin, in our example, was then taken and used as collateral in other deals. This leveraged up the system, something that collapsed as prices declined. If it was just the original parties, no problem. A loss is incurred by someone who took the risk.
Sadly, as depositors found out, their risk was greater than they imagined. The collateral was not available to return, meaning withdrawals were closed.
Hence we were left with nothing more than a duplication of the existing system except using cryptocurrency.
Hive Bonds
How does Hive Bonds potential change the equation?
As we are going to see, this has the ability to solve the present shortage in collateral while also removing hypothecation from the equation.
To quickly recap, Hive Bonds start with the deposit of the Hive Backed Dollar (HBD) into savings. This earns a return, right now paying 20% APR. The withdrawal period is 3 days, meaning there is a short-term lack of liquidity.
There is an idea to create time vaults. This will allow for a larger return in exchange for a longer time commitment. Here the lack of liquidity becomes evident.
Hive Bonds is taking the HBD deposit it creating a token. Effectively, this will be a NFT tied to that financial transaction. This is done with the use of a smart contract, where the HBD is deposited and a NFT pops out. This is then tied to a DEX, where it can be exchanged. At the same time, lending applications can accept this as collateral on loans.
We can already see how rehypothecation becomes impossible. The individual is in full control of the assets at all times. Since we are using a smart contract, the counterpart is limited to the contract (and the blockchain itself). There is no company involved.
What about the shortage of collateral? Here is where Hive's unique design enters.
If more collateral is needed, it is simply created. This means more HBD is placed into the smart contract. Of course, what if there is not enough HBD? Again, we create more.
Here is where some might start cringing at thoughts of the Fed, money printing, and inflation. Again, understanding HBD and HIVE means we are dealing wiht something totally different.
How do we create a massive amount of HBD? The only way is to convert HIVE. This means that $25 million worth of HIVE is needed to create $25 million in collateral. What happens if that entity doesn't have $25 million in HIVE? Purchasing on the open market is required.
It becomes obvious what happens when buy demand is added. Price go up. Hence we have a situation where the need for collateral means that the HIVE price is driven higher.
The counterparty risk associated with CEX like FTX is removed from the equation. We are literally dealing with nothing more than a smart contract and the Hive blockchain. Here is where having decentralized node system removes the fragility commonly associated with the existing financial system.
In short, Hive could potentially solve two major issues we see with the existing financial system. And, unlike what we saw so far in cryptocurrency, it is not simply replicating the shortcomings that system puts forth.
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