A Crypto Fix For A Broken International Monetary System (#GotBitcoin?)
The international monetary system is broken. Helping to fix it poses a huge opportunity for the cryptographers behind cryptocurrency and blockchain technology. A Crypto Fix For A Broken International Monetary System (#GotBitcoin?)
Now they have one of the stewards of that system in their corner: Mark Carney, the outgoing Bank of England Governor.
A week ago in Jackson Hole, Mont., Carney told the Federal Reserve’s annual gabfest that central bankers could develop a network of national digital currencies to create a new, basket-managed “synthetic hegemonic currency.”
Carney’s proposal was mostly a thought exercise to inspire conversation around solutions to the dangerous imbalances fostered by the current system’s dependence on the dollar as the world’s reserve currency. The specifics were necessarily thin – any solution will be both technically and politically complicated, and even though he’ll depart the BOE in January, Carney’s status as a public official demands caution.
But I don’t share those constraints. So, let me lay out my own modest proposal for a cryptocurrency-based fix to a broken global financial system. Hint: it is not “buy bitcoin.”
I’m neither a trained economist nor a cryptographer, so I know this act of hubris will attract naysayers. I welcome criticisms and suggestions. I’m also quite certain I’m not the first to think of this, so I’m eager to hear of others working on similar projects.
The thing is I’ve been obsessed with both the structural failings of the global financial system and cryptocurrency for many years now. Three of my five books have covered those topics. It’s hard to bite my tongue.
Fixing The Global Currency System
I think that instead of creating a whole new global currency, central bankers should work to develop digital currency interoperability. We need a system of decentralized exchange through which businesses in different countries can use smart contracts to create automated escrow agreements and protect themselves against exchange rate volatility. With algorithms that achieve atomic swaps now available and with other advances in cross-chain interoperability, I believe we’ll soon have the technology to remove foreign exchange risk from international trade without relying on an intermediating currency such as the dollar.
Here’s how it might work: A hypothetical importer in Russia could strike a deal with an exporter from China and agree to a future payment, denominated in Chinese renminbi, based on the latter’s prevailing exchange rate with the Russian ruble. Relying on an interoperability protocol that’s commonly integrated into each party’s preferred digital national currency – either in privately run stablecoins or central bank-issued digital currencies – the two firms could then establish a smart contract that “trustlessly” locks up the required renminbi payment in decentralized escrow. If delivery and contract fulfillment are confirmed, the payment is released to the Chinese exporter. If not, the funds revert to the Russian importer at the same, initial conversion rate.
In this scenario, both parties are protected against adverse exchange rate movements. Yet, despite the trust gap between them, there is no need to intermediate the payment through dollars, and no need for either party to take out a forward contract, FX option or some other expensive exchange rate hedge.
Of course, the importer would suffer the opportunity cost of locking up otherwise valuable working capital for a few months. But private banks could mitigate that with collateralized short-term loans on terms that would be a lot cheaper than the current cost of currency hedging. Alternatively, if the smart contract is executed on a proof-of-stake blockchain, the locked-up funds could be employed to earn cryptocurrency staking rewards.
What Would Central Banks’ Roles Be?
Well, for one, they could backstop the entire credit and/or staking model. Providing liquidity or guarantees to banks’ trade finance businesses would be a more constructive use of domestic money supply than applying it to rainy-day funds of U.S. Treasuries and other dollar assets.
Secondly, they’d be charged with assuring the trustworthiness of the interoperability protocol. Whether central banks would endorse and regulate privately developed protocols such as Tendermint’s Cosmos, Parity Technologies’ Polkadot or Ripple’s Interledger, or whether they would commission a multilateral body to build and manage a single official system, there’s no getting around an oversight role for public sector policymakers.
(Don’t worry, crypto libertarians, no one’s taking away your bitcoin in this scenario. In fact, since central bankers will retain their own monetary sovereignty, with exchange rates continuing to fluctuate, bitcoin’s appeal as a “digital gold” alternative to domestic currencies could well be enhanced.)
A Broken System
Let’s be clear: if foreign trade no longer requires dollar intermediation, the U.S.-centric global economy will suffer a massive impact, perhaps bigger even than the 1971 “Nixon Shock,” when the dollar was unpegged from gold.
The entire reserve currency system, in which foreign central banks own U.S. government bonds as a backstop and multinational companies hold large parts of their balance sheets in dollars, is based on the need to protect against exchange rate losses. If that risk is removed, the edifice would, in theory, come down.
Yet, as Carney rightly points out, continuing with dollar hegemony is not tenable, either. The system is broken. Whenever global investors get the jitters they rushen masse into “safe haven” dollar assets – even when, as with President Trump’s trade war with China, U.S. policy is the cause of their malaise.
This process, which has become progressively more acute with each financial crisis, causes huge distortions, economic dysfunction and political turmoil. And with economies slowing and the worldwide value of bonds carrying negative yields now at $17 trillion, we now face worrying signs of another crisis. This time, traditional central bank policy could be powerless.
When another crisis comes, the dollar-based system will generate a predictable vicious cycle. The dollar will rapidly rise. This will hurt U.S. exporters, which further stir the mercantile instincts of anti-free traders such as Trump and fuel risks of a destructive tit-for-tat currency war.
Meanwhile, emerging markets will suffer capital flight as a rising dollar raises the risk of debt defaults in those countries. Their central banks will respond by jacking up interest rates to prop up their domestic currencies, but this will choke their economies at a time when they require easier, not tighter, monetary policy. Unemployment will surge and governments will topple.
The current system breeds what former Fed Chairman Ben Bernanke dubbed the “global savings glut” as developing countries squirrel money into dollar reserves that could otherwise be used for domestic development.
In the U.S., it creates the countervailing effect of massive deficits – in other words, sky-high debt. Far from being the “exorbitant privilege” once described by French Finance Minister Valéry Giscard d’Estaing, the dollar’s reserve status is an American curse. It creates artificially low U.S. interest rates, which misprices credit risks and fuels bubbles – see: the 2008 housing crisis.
Worst of all, the dollar system undermines democracy and diminishes economic sovereignty. The performance of every economy hinges on U.S. Federal Reserve policies. Yet the Fed’s low inflation/maximum employment mandate is defined only by the U.S. economic outlook. This policy mismatch makes it much harder for governments to pursue effective measures to create opportunities for all.
When things really go sour, the Fed belatedly and reluctantly becomes the world’s lender of last resort, pumping dollars into the world’s banks via their New York subsidiaries. That’s how we ended up with the “quantitative easing” surfeit after the last crisis, money that went into financial assets, London real estate and fine art, but did little to boost the earning power of the middle class.
These policy failures have bred a populist backlash against globalization, manifest in the U.K.’s Brexit crisis and President Trump’s adversarial trade policies. Yet the reality is that capital flows are more globalized than ever and increasingly beating to the drum of the U.S. dollar.
So, Yes, We Need Change. The Question Is How And In What Time Frame?
Violent Or Managed Change?
The solution I described could be adopted abruptly and disruptively or it could be cooperatively managed for a smoother transition.
Under the first scenario, let’s consider Russia and China, the two countries I deliberately chose for my explanatory example, since they are believed to be further ahead than most in developing fiat digital currencies. Both would love to do away with dollar dependence. Could they go it alone and jointly devise a bilateral, cross-chain smart contract between a digital renminbi and a digital ruble? Sure. Would other countries follow suit? Maybe. Such an uncontrolled retreat from dollars could do huge harm to the U.S. and the overall global economy.
That’s why I think central banks should heed Carney’s call and work together on a solution. They could coordinate the gradual introduction of digital currencies, selectively managing access and applying differential interest rates to discourage an exodus from shaky banks. They could also charge the IMF with seeking a global standard for cross-chain interoperability.
Regardless, the disruptive technologies behind digital currencies, stablecoins and decentralized exchanges will advance. It’s a ticking time bomb.
Crypto Loans See Solid Growth, Platforms Attract Community Interest
It may seem surprising, but platforms designed for loans and lending through the use of cryptocurrencies are a relatively new development for the crypto industry. Each platform adheres to its own strategy, but the idea shared by all is that users put their cryptocurrency into an automated smart contract as collateral for a loan.
The contract tracks accrued interest and credit payments and also prevents anyone from interfering in this process. Unlike traditional lending, there is no need for credit checks and scoring, as well as for the lender to seriously consider the option of physical pressure on the borrower.
A young industry
Cryptocurrency loans platforms began to develop during the bear market of 2018, as crypto prices became critically low at the peak of the downturn. At the time, owners of digital currencies who didn’t want to sell their crypto at low prices lent out their holdings and made money on interest.
The Popularity Of Lending In Digital Currencies Has Grown For Several Reasons:
Low Interest Rates
Increase In The Number Of Traders And Investors For Whom Receiving Funds Immediately In Cryptocurrencies Is Convenient
A Simplified System Of Requirements For Borrowers; Those Who Hadn’t Been Approved For Bank Loans Could Easily Receive Digital Money
Today, the entire crypto loaning industry is estimated at $4.7 billion and the number of crypto loan platforms is growing rapidly, according to a report made by blockchain company Graychain Ltd. While lenders have only earned a combined $86 million in interest since 2018, the demand for cryptocurrency loans is growing. In the first quarter of 2019, over 5,400 new loans were issued, and in the second, at least 18,500. The volume of lending also increased, with lenders issuing $64.8 million in loans in the first quarter and $159.3 million in the second.
Thus, it is clear that, despite its newness, high risks, and very low profitability, this new crypto industry is gaining momentum. There are also critics of crypto loans who claim that crypto credit is expanding too quickly and will explode, as the signs of a bubble in this area are too similar to the traditional problems of financial markets: low lending standards and an excessive supply of funds with little demand and increased risk.
Which loan to choose and where
Crypto lending can be divided into two main areas: depository and undetectable.
Depositary lending is more centralized. It involves securing a loan through a trusted third party, who is given a significant level of authority through complete control over user assets, setting interest rates, and acting as a counterparty in each transaction.
Depositary lending is the most popular form of crypto loan and is used by several large credit companies, such as Genesis Capital, Celcius Network, Salt Lending and others.
The second crypto lending path is non-custodial in nature and more decentralized, which better serves traders and retail investors. This type of lending is mainly supported by the developing class of decentralized applications created on Ethereum.
Using smart contracts, these platforms can create a system in which users don’t need to trust centralized authorities, as smart contracts show all the processes throughout the entire life cycle of the loan and are automatically repaid. Paul Murphy, co-founder and CEO of Graychain, a crypto credit rating platform, believes that finding a convenient service is not a problem:
“In places with thriving, well-developed financial systems crypto is being absorbed as new asset class. This will continue to happen under the watchful eyes of regulators. Despite the constraints we can expect to see innovation because of crypto’s unique properties. We can expect to see crypto lending continue to develop in places like the US, EU, Japan, HK, and Singapore.”
Murphy believes that in less developed countries, where traditional finance has a weak foothold, regulatory structures are weak, and many citizens are unbanked, cryptocurrencies allow a new financial system to emerge:
“We are currently seeing the most activity in South East Asia but also lots of interest throughout Africa. There is some interesting work being done in Latin America, but most interesting projects are moving out of the region. This isn’t surprising as many people in Latin America have relatively close ancestral ties to Europe.”
Crypto Loans Platform Comparison
Spread out all over the world, below are the most distinctive crypto lending platforms.
Founded in June 2017, BlockFi is a New Jersey-based crypto asset management company that allows users to earn interest and borrow money through offering crypto as collateral. BlockFi works with Gemini Trust Company, which is fully licensed by the New York State Department of Financial Services.
The company specializes in two types of services: interest-bearing accounts that earn money, and quick loans with Bitcoin, Ethereum and Litecoin.
Each loan is issued on the basis of a loan-to-value ratio. Since the loans offered by BlockFi are secured by assets, the company does not require credit score checks of its users. BlockFi customers receive money against their Bitcoin, Ethereum or Litecoin collateral with a loan-to-cost ratio of up to 50%.
The loan-to-value ratio determines how much collateral is required to get a certain amount in dollars. Collateral guarantees that the borrower will be interested in repaying the loan, and is used to repay the lender in the case of nonpayment.
Each loan issued by BlockFi is for a duration of 12 months, with the ability to make early payments at any time without commissions and penalties. BlockFi interest rates begin at 4.5%, depending on the loan-to-value ratio. BlockFi also enables its users to earn interest on deposits through the BlockFi Interest Account, which provides up to 8.6% per annum.
BlockFi generates interest by accepting deposited assets and providing them on credit to trusted third-party institutional and corporate borrowers. Such loans also have collateral and have the same structure as BlockFi crypto loans.
Crypto Lender BlockFi Rolls Out Zero-Fee Trading for Bitcoin, Ether, GUSD
BlockFi, the cryptocurrency lending service backed by Galaxy Digital, Winklevoss Capital, ConsenSys Ventures and others, is expanding into trading with an unusual, zero-fee model.
The startup has made a name for itself by offering investors a way to realize a return on their crypto without selling it. Clients deposit bitcoin, ether or the GUSD stablecoin with BlockFi, then take out U.S. dollar loans against their crypto collateral or earn interest on their deposits. BlockFi lends the crypto to big institutional players that use it for trading and pay interest, which the lender passes back to depositors.
Starting Thursday, users have one more option: they can buy or sell using their balances – for example, buy more bitcoin using the GUSD or ether they’ve deposited or vice versa.
There will be no trading fees, as the service will have a different profit model: the money will be coming from selling data on the users’ trades to big institutional crypto firms that, in turn, will act as market makers at BlockFi, providing liquidity.
“Market makers want the information about what trades are happening, and they get it by having relationships with as many venues as they can support to receive that order flow,” BlockFi CEO Zac Prince said. The data will be anonymized when the service is up and running, the company said.
Some of these market makers have been BlockFi’s clients on the crypto lending side already, and some of them are also the startup’s equity investors, like Susquehanna, Akuna Capital and CMT Digital, Prince said. The fact that the institutions will be doing multiple activities on BlockFi will help build strategic relationships with them, he said.
BlockFi decided to expand into the exchange business after a customer survey found users tended to withdraw their crypto for trading purposes, Prince said.
“We ask a subset of clients ‘why are you withdrawing?’ when they do withdraw and the most common answer has been ‘to trade’,” Prince said. “Our existing user base wanted to trade and requested that we build a product for trading on our platform.”
BlockFi will also add more options for interest-earning accounts and trading: starting Dec. 11, users will be able to deposit and buy USDC and litecoin.
The company would not disclose exact numbers, but, according to Prince, “tens of thousands” of people are now keeping their crypto with BlockFi, and more than 50 institutional players are borrowing from it. But that’s not enough for this venture capital-funded outfit: in addition to experienced crypto holders, BlockFi wants to attract first-time buyers, too.
For this category, BlockFi is planning to open fiat-to-crypto trading, Prince said. The fiat gateway is expected to go live sometime during the first quarter of 2020. BlockFi has been ramping up its compliance work: the company recently secured a money services business (MSB) registration with the U.S.
Financial Crimes Enforcement Network (FinCEN)
It’s also working on getting money transmission licenses in a bunch of states — Prince wouldn’t disclose which ones but said BlockFi is “pretty close” to getting a license in some of them.
And its ambitions go further: in the second half of 2020, BlockFi is planning to launch a crypto rewards credit card.
“Up until now, we’ve been focused on building products for existing crypto investors so they could get the same type of services as in traditional finance. In 2020, we’re going to launch products that will enable us to add new consumers to the crypto ecosystem,” Prince said.
When the clients buy crypto on BlockFi it will automatically go into their interest accounts and start earning interest if a client chooses this option, Prince said. BlockFi launched the interest-earning accounts in March, offering up to 6.2 percent in compound interest on bitcoin and ether deposits.
BlockFi has changed the terms for the interest accounts several times: in April, the rates were cut for accounts larger than 25 bitcoin or 500 ether; in May, the threshold for lower rates dropped further to 250 ETH and later on, to 5 BTC and 200 ETH.
Last week, the terms changed again: now the 6.2 percent rate will be applicable to holdings lower than 10 BTC, while everything a user have above this will earn only 2.2 percent annually. For ether, deposits below 1,000 ETH will be earning 4.1 percent annually, and everything above only 0.5 percent. The rate for any amount of GUSD is now 8.6 percent.
Prince explained that the changes in the terms had to do with the balance between retail clients who are keeping their crypto at BlockFi and institutional clients that are borrowing crypto for trading.
“Initially, we were positively surprised how much we received on the side of deposits and we had to give the institutions time to catch up,” Prince said. Now, “we’ve never been so balanced, and it’s growing every day,” he added.
As for the latest change, “we raised the tiers because we were seeing an uptick in demand and wanted to raise more supply, plus, pass on more of the value to our clients,” Prince said.
Initially backed by ConsenSys Ventures, SoFi, Kenetic Capital and Galaxy Digital, BlockFi brought in more investors in an August Series A round, including Peter Thiel’s Valar Ventures, Winklevoss Capital, Morgan Creek Digital and Akuna Capital.
The recent $18.4 million funding helped to substantially grow the team: compared to about 30 people that had been working at BlockFi this summer, the company now has over 60 people, half of them engineers, Prince said.
There has been some finance talent acquisition, too: in October, the company hired Jessica Raybeck, a former vice president at Nomura and Citi, as the head of institutional client relationship management.
One of the first platforms in the market was SALT, short for Secure Automated Lending Technology. The project was founded in the United States in 2016. It is a blockchain-based lending platform that allows users to receive funds directly to their bank accounts. Currently, SALT Lending has expanded to 33 U.S. states and also operates in the United Kingdom, New Zealand, Hong Kong and Vietnam.
The most important participants of the platform are lenders, as SALT provides them with the infrastructure, flexibility and security necessary to accept coins without adding additional costs to the process. In exchange for these services, lenders pay for membership on the platform. The service never asks for a credit rating — instead, it uses only the value of collateral to determine the terms of the loan.
Lenders begin the process by publishing the terms on which they are ready to provide a loan. Borrowers can browse through various options and choose the one that best suits them. As soon as borrowers choose a loan, lenders hold the corresponding funds until the borrower provides a security using a smart contract. Funds are then sent directly to the bank account.
The borrowers then pay monthly installments toward their loan according to its terms, and when the loan is repaid, SALT releases the security deposit from the smart contract and returns it.
SALT Oracle creates a smart contract for each loan and credit event. To reduce the risk of nonpayment, the Oracle records all payments made on loans and monitors changes in the value of provided cryptocurrency collateral. Each loan starts with a credit-to-value ratio that is calculated based on current market prices.
SALT tokens, also known as membership tokens, are based on the ERC20 standard and are required to purchase membership on the platform. Bitcoin (BTC) and Ethereum (ETH) are both accepted on the platform, and as of April 2019, the company announced that it will also work with Dash as collateral for loans.
Established in 2017, Nexo is an instant lending platform that claims to have a military level of security (256-bit encryption). To start the loan process, users transfer assets to their secure Nexo wallets, where these assets come under the protection of the BitGo repository. Then, users may obtain instant credit. The platform accepts submissions of BTC, ETH, XPR, LTC, XLM, BCH, stablecoins, NEXO tokens and BNB as collateral.
After confirming the collateral, the Nexo Oracle evaluates the collateral and then calculates a suitable loan-to-value ratio. After the LTV is calculated, users receive money directly in the form of fiat or a stablecoin.
Repaying a loan to Nexo is quite flexible, as users are not required to repay monthly until their balance is less than the loan limit. Like SALT, Nexo tokens can be used to lower interest rates and repayments.
Borrowers can take advantage of a 50% discount on the loan’s interest rate if the security deposit or loan repayment is paid in Nexo tokens. Users of the platform can repay all or part of their loans at any time via bank transfer, cryptocurrencies or assets deposited in their Nexo wallet.
Once borrowers have repaid the entire loan amount along with interest, they can easily withdraw their crypto assets from their wallet. George Manolov, business development executive at Nexo, pointed out that users pay interest only on what they actually spend:
“Our customers only pay interest on the amount they borrow. In contrast, other lenders require you to withdraw the entire amount of a loan at the time of origination, meaning customers pay interest on their full loan.”
The Celsius Network was created in 2017 and is a crypto credit platform providing a new model of financial services that act in the best interest of the community. It has a mobile app that allows users to earn interest on stablecoins and a number of cryptocurrencies.
The Celsius platform allows borrowing money against crypto collateral at interest rates as low as 4.95% per annum. This interest rate works mainly for dollars as well as stablecoins such as USDT and USDC, and the minimum loan limit is $1,500, which needs to be backed by an equivalent amount in crypto.
Celsius has a full-fledged transaction instrument called CelPay, which works as a wallet that allows free cryptocurrency transfers from one wallet to another. Furthermore, Celsius Network charges no fees for withdrawals, deposits, transactions or early terminations. The platform has its own token, CEL, which is purely a service token that is used to provide users with discounts on borrowing and deposit services.
Additionally, any user can become a lender by putting their crypto into cold storage and earning interest from it. Regardless of the amount that users are ready to put in, they earn weekly interest in either the same token deposited or the native CEL token.
At the moment, Celsius Network is one of the biggest crypto loan platforms in the world, reaching $4.25 billion in total crypto loans in November.
YouHodler is a Swiss company that specializes in providing a cryptocurrency line of credit and a cryptocurrency exchange platform. Founded in 2018, the company’s mission is to minimize passive ownership, allowing investors to earn interest on their assets or borrow money.
One of the most core products offered by YouHodler are cryptocurrency loans, available in tokens such as BTC, ETH, XRP, Dash, LTC and so on. Depending on the token, users can choose one of the available plans, which differ by loan period. For example, users can choose plans that range from 55% to 95% in cost ratio, from 5% to 40% in price reduction, and a loan period from 30 days to 180 days.
The company does not perform any credit checks, as user credit scores are meaningless to the loan application process. Borrowed money is fully secured by cryptocurrency and is based on the loan-to-value ratio. Because of this, even if users cannot repay their loan, their credit score will not be affected.
Additionally, YouHodler has a Turbocharge service, which allows users to get a chain of loans. The platform uses borrowed fiat to purchase additional cryptocurrency without commission and then uses it as collateral for other loans in the chain. Ilya Volkov, CEO of YouHodler, says the option is popular among traders:
“Clients were using loans to buy more crypto to use as collateral for yet another loan and then using that again to buy more crypto for collateral. They would do this process manually multiple times. So, we invented an automated tool that completed this chain for them in one click.”
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