CryptoCurrencies – The Manifest Absurdity of the Stablecoin

 

Just the other day, there was an article in the FT about "stablecoins" describing them as a "link" between traditional curriencies and cryptocurrencies.

There is quite a lot of manifest absurdity in the world these days, economics, politics, and matters financial.

To set the stage for today's exploration, a review of the "logic" for cryptocurrencies.

Proponents argue that:

1. Government-issued currencies are not "backed" by real assets. e.g., gold.

2. Governments can therefore issue as many "fiat" currency notes as they wish. Thus eroding value via inflation.

3. Electronic payments made with "fiat" currencies are subject to (a) surveillance and (b) seizure by pressumably intrusive and untrustworthy governments.

Cryptocurrencies are the "answer" because:

1. They are created by private sector entities and thus free from the "malign" behaviour of governments.

2. A key assumption (delusion) here is that private sector entities' honesty is beyond question.

3. While like fiat currencies cryptocurrencies are not backed by real assets, their value depends on and is obtained through the operation of the market.

4. A key assumtion (delusion) here is that the "market" never misvalues an asset either because of irrational exuberance, manipulation, market failure, etc.

5. Electronic payments made with cryptocurrencies are immune to (a) surveillance and (b) seizure by those presumably malign and untrustworthy governments.

6. A key assumption (delusion) is that movement via a trading platform from "fiat" currencies to "cryptocurrencies" and vice versa is not subject to (a) surveillance and (b) seizure by untrustworthy and malign governments.

7. Elliptic a blockchain/crypto security company claims to have traced Colonial Pipeline's ransom payment to a BTC wallet to which apparently other such payments were directed. And then payments out of that wallet.  Another delusion hits the wall.

So now to the "stablecoin"

1. Having trashed "fiat" currencies as unreliable and potential unstable, some stablecoins offer the investor the proposition of indirectly holding "fiat" currencies, e.g. tether.

2. In such cases, the stablecoin claims to hold one unit of fiat currency for each unit of cryptocurrency. So let's get that straight. It's backing its "currency" with the "real" asset of a "fiat" currency. But with the holder of the stablecoin assuming the risk of the intermediary between the Central Bank issuer of the fiat currency.  

3. Some stablecoins are tied to bitcoin or other sh*tccoins. Exactly how the underlying volatility of those "assets" is managed is no doubt a combination of "naive belief", "magic", and derivatives. The latter being the last (valuation) refuge of scoundrels and conmen.

4. Some stablecoins can in the words of Celsius pay interest 100X what one can earn in the bank market for fiat currencies. As of August 2020, capable of earning up to 16% per annum!

5. A key assumption (delusion) is that such returns make economic sense from investing in a non-productive asset. At least Tesla has a "real" business selling emission credits to third parties, even though that market appears to be shrinking!

So let's look a bit closer at the first class of stablecoins – those "tethered" to a fiat currency.

As background, here's a link to the settlement agreemen effective 18 February 2021 between the NY State Attorney General and iFINEX INC., BFXNA INC., BFXWW INC.,TETHER HOLDINGS LIMITED, TETHER OPERATIONS LIMITED, TETHER LIMITED, TETHER INTERNATIONAL LIMITED.

The pattern of behaviour recorded in the settlement agreement should demonstrate the fallacy of several of the assumptions (delusions) cited above.

It should also demonstrate the additional risk that such entities face in obtaining the services of creditworthy financial institutions.

When one is forced to deal in the “odd and out of the way corners” of financial markets, with undercapitalized institutions in less than ideal jurisdictions, including non banks, one’s business is subject to greater risks.

And those risks ultimately flow to the “wise” investors who have placed their funds with “one”.

Bitfinex is a cryptocurrency trading platform that allows its clients to trade between fiat and cryptocurrencies.

Tether is a stablecoin which claims to hold one US dollar in reserves for each “tether” issued.

It is by most accounts the “largest stablecoin in the cryptospace”!!!!

The companies are related parties.

Initially, Bitfinex and Tether worked through banks in Taiwan that had correspondent relationships with Wells Fargo Bank. In early 2017 WFB stopped processing transactions for Bitfinex and Tether.

In June 2017 Bitfinex opened an account with Noble Bank International Puerto Rico.

NBI was formed under Act 273 of Puerto Rico which provides for the creation of offshore financial entities. Such entities enjoy tax benefits and may not offer services to residents of Puerto Rico. They must have a minimum capital of US $5 million of which US $250 thousand must be paid in, and four employees.

Just the sort of financial “institution” one might think a good place to plunk down US $500 million of one’s “spare” change. Or more precisely one's customers' hard earned money.

Tether for its part kept its US dollar reserves at the Bank of Montreal but the account was in the name of its attorney.

Presumably, that was because BoM didn’t want to “entertain” an account from Tether.

Until September 2017, Tether (or more precisely its attorney) held some USD 61 million in that account. At that point some 442 million tethers (worth US $442 million) were in circulation. 

Even without a calculator you should be able to determine that the "collateral" coverage was less than 1 to 1.

During that time Bitfinex held US $382 million of Tether’s funds in its account.

After 15 September Tether opened an account at NBI and Bitfinex transferred the funds to Tether’s account.

Between 2018 and 2019, Bitfinex had problems finding an FI willing to handle its transactions.

So it turned to Crypto Capital in Panama to hold its funds.

By 2018 CC held some US $ 1 billion of Bitfinex's funds or more accurately its customers' funds.

No doubt it sounded like a great idea to plunk down US $1 billion in a non bank.

What could possibly go wrong?

Bitfinex's contact there was "Oz Yousef" or just "Oz".

I'd hasten to add that it's not clear from the settlement agreement whether Oz was a wizard or not.

Oz responded to Bitfinex's subsequent requests for its funds with a variety of excuses as to why the funds couldn't be moved.

Bitfinex nevertheless continued to direct new clients to remit funds to CC!

Apparently when you've got a guy like Oz handling your money, you can't let a few bumps in the road disturb the relationship.

During the summer of 2018, Bitfinex "borrowed" US $ 400 million from Tether.

Oz still was holdiing on to CC's money.

The two entities relationship with NBI was terminated and funds shifted to Deltec Bank Bahamas.

Bitfinex repaid Tether's initial US $400 million "loan" by redeeming an equal amount of Tethers.

Oz still wasn’t releasing Bitfinex’s funds.

2 November 2018 Tether remitted US $475 million from its account at Deltec Bank to Bitfinex’s account at Deltec bringing the total “loan” to some US $ 625 million.

In February 2019 Tether updated its website to state that “[e]very tether is always 100% backed by our reserves, which include traditional currency and cash equivalents and, from time to time, may include other assets and receivables from loans made by Tether to third parties, which may include affiliated entities (collectively, ‘reserves’).”

Tether did not announce that it had changed its disclosure, and indeed there were no media reports about the change until several weeks later on March 14, 2019.  

It also did not provide a breakdown of its "reserve" holdings which would have shown that the bulk of these were in the form of loans to Bitfinex.

Subsequently, Bitfinex and Tether agreed a “credit” agreement under which Bitfinex could “borrow” up to US 900 million of Tethers funds (the supposed reserves for Tether). This appears to be part of a “regularization” on an existing US $625 million existing loan.

As of the date of the settlement agreement, Oz still hadn’t released any of Bitfinex’s cash or as noted above more precisely Bitfinex’s customers’ cash.

BIS Releases Discussion Paper on Designing Prudential Treatment for Crypto-Assets

Yesterday the BIS Basel Committee on Banking Supervision (BCBS) released a discussion paper on “Designing a Prudential Treatment for Crypto-Assets”.

The purpose of the paper is to solicit comments about several principles that the BIS BCBS proposes to employ in designing such a framework.

It’s important to note that the BCBS does not have the legal authority to compel national jurisdictions to accept its rules and regulations.

Rather it relies on its influence as a multi-national organization to secure voluntary co-operation.

In that regard, it is like the FATF/GAFI—which develops standards for anti-money laundering and countering the financing of terrorism. Both are the primary global standard setters for their respective areas of expertise.

The BCBS’s clout derives from its membership – 45 regulators and banking supervisors from 28 jurisdictions across the globe.

Failure of a national jurisdiction to accept BIS or FATF/GAFI standards generally places it “outside” of what are generally accepted norms and places it at a disadvantage to those jurisdictions that accept the standards.

It’s also important to note that the BCBS sets standards for financial institutions and their regulators.

So this exercise doesn’t seek to directly regulate Crypto-Assets but rather banks involvement with this asset class and how national regulators would assess and control the risks that these assets pose to individual banks and national and global banking systems.

Key elements from this paper are:

1. The BCBS assessment that Crypto-Assets do not meet the definition of currency – medium of exchange, store of value, unit of account. Hence the BCBS’s use of the term Crypto-Assets instead of Crypto-Currencies. That may seem like arguing over semantics.  But if the BCBS pronounces that Bitcoin et al are not currencies, it is likely that national regulators will adopt a similar view with consequences for their treatment of these assets.
2. The BCBS view of risks of these assets.
3. The proposed prudential (regulatory) treatment of banking exposures to these assets in view of the perceived risks.

This paper isn’t the final word.  Rather it’s the first step in the process.

The BCBS will publish comments it receives.  Those interested in crypto-assets will find these replies useful in furthering their understanding of this asset class.

Financial Action Task Force to Issue Anti-Money Laundering Guidelines on Virtual (Crypto) Assets

On the chance you missed it …

FATF is expected to issue recommendations regarding Anti-Money Laundering procedures that should be applied to virtual assets, e.g., Bitcoin et al. If these reports are true and FATF adopts its typical formula for standards, this which will fundamentally change these assets.

The FATF is an iinter-governmental international organization that issues standards for combatting money laundering and terrorism finance.

It does not have the power to issue laws which bind individual countries. But its standards are generally but not always adopted by countries into their national laws.

Why?

Countries that don't adopt or sufficiently implement FATF standards on AML and countering terrorism finance are identified by FATF as "high risk and other monitored jurisdictions".  The financial community then imposes special measures when dealing with these countries or more simply "black-lists" them.  Typically countries fall in line, though there are some exceptions, e.g., DPRK.

FATF's recommendations tend to focus on two areas:

1. CDD or KYC - That is, knowing the identity of the customer through obtaining various information evidenced by documents (e.g., for an individual a copy of a passport or national ID card, proof of address) and as well the customer's financial status and any special status, e.g., politically exposed person.  This information is generally to be periodically reviewed and updated as necessary
2. Transaction Monitoring - Scrutinizing of transactions to identify any that are suspicious with subsequent further review/investigation of the transaction.  If after the investigation, it appears that the transaction is suspicious, a report must be filed with the designated national authority.

These measures go to the heart of one of the two touted features of crypto-assets; anonymity.   

The other major feature that the crypto-assets are backed by air remains intact.

السماء لا تمطر ذهباً ولا فضة One Gram

Personal preference: AA would remove the "l" above.  3:160

No, AA hasn’t branched out into pharmaceuticals. 

An article in Gulf News caught my eye “Buy Property in Dubai with Crypto-currency.” 

“OneGram will go live in June next. Investors in MAG properties will purchase OneGram to the value of the property and receive a 5 per cent discount on the property price as a result. The OneGram will then remit to MAG according to the payment plan, which is 35 per cent over six to nine months and 65 per cent on completion at the end of 2019”

At first blush this sounds like a great deal.

Assume you want to buy that corner unit in برج أوهام for AED 3 million.  Right off the bat you’ve saved AED 150,000.

But a closer look indicates that the deal may not be as sweet as the result of patience. 

Let’s look at the Shari’ah whitepaper prepared by OG’s advisor, AlMaali Training and Consultancy, specifically at the fee discussion on pages 16-17.

First, there is a 10% purchase fee equal to the amount of OG one wants to buy.  That’s 10% of AED 2,850,000 (95% of AED 3 million).  Or AED 285,000.   Oops, we now appear to be AED 135,000 in the red.  (AED 150,000 less AED 285,000)

But as they say “wait there’s more”.  There’s also a 1% transaction fee for another AED 28,500 for a grand total of AED 163,500. 

Thus, we’ll pay AED 3,163,500 for our AED 3,000,000 apartment. 

And as per the above quote, we’re required to pay 100% of the price to OG up front who will then carefully safeguard 65% of our funds until 2019 (roughly two years) when MAG is owed the money.  No interest paid I suppose since this is an “Islamic” financial instrument.  No need for any present value calculations even if based on "profit rates" as opposed to interest rates.

Despite all this, we can take comfort from using an innovative new Islamic financing tool and helping a deserving firm make a nice profit.  Can’t we? 

If you’re wondering, the 10% entry fee is used for the following purposes:

1. 5% (or 50% of the total fee) for long term business development. 
2. 1.5% (or 15% of the total fee) for marketing costs. 
3. 1.5% (or 15% of the total fee) for operations –gold transport, fee for offering spot price, storage, insurance. 
4. 2% (or 20% of the total fee) for salaries.

The 1% transaction fee is allocated as follows: 

1. 70% to buy additional gold to back each OG token.  What this means is that over time more than one gram of gold will back each token.  Of course, if you sell your OG, you don’t share in this benefit. The chap who buys from you does unless some how you can work that future benefit into the selling price you receive. On that basis, the business logic of this mechanism escapes AA.   If one uses OG as a medium of exchange, the benefit of this feature would appear to be small.  If one were getting OG tokens for free as a “miner” or perhaps in some other way (founder), this could be quite attractive. Having said that another Dubai-linked gold cryptocurrency Currensee has a similar mechanism, though 80% of the their 1% transaction fee will purchase additional gold.  Interestingly their maximum transaction fee appears capped at USD 10.  Currensee whitepaper page 9. 
2. 10% for operations and development.  The whitepaper has an error here and in the next two categories.  It states 2.5%, though from the numbers provided example it’s clearly 10%. 
3. 10% for charitable contributions. 
4. 10% for the “miner” reward with the caveat that under Shari’ah there can be no guaranteed returns.  It’s unclear what this is all about on two fronts.  First, the whitepaper describes the “miner” as the “investor”.    Second, if this is truly a transaction fee, it would seem that it would be perfectly halal.

There’s a different version on the allocation of the 1% transaction fee in the English “whitepaper” written by I.M. Khan in categories 2 to 4 above.  On page 6 the operations and development fee is 25% (Currensee takes 20%) and the charitable deduction and mining fee (here clarified as a fee for blockchain processing) are each 2.5%.  In IMK’s estimation the transaction fee is “minimal” compared to “traditional banking” (page 2). 

Analyst disclosure:  In all AA’s personal traditional banking relationships I pay no more than a flat USD 45 fee for a payment.  This is with both OECD and non OECD banks. The firm I work for has an even smaller cost. 

All OG’s fees—set on transaction amounts--look like a sweet deal for someone but perhaps not necessarily investors in OG.

By comparison Bitcoin’s transaction fees are a flat per transaction fee not a percentage of the amount.  Recently, there was a bit of a hue and cry over a temporary spike in Bitcoin’s transaction fee to USD 26.  At OG, you could move USD 2,600 equivalent for that fee!  If you wanted to move more, the OG fee would be higher.  

Bitcoin transaction fees vary by demands on the capacity of the (Bitcoin) Blockchain, resulting from what appears to be a rather small maximum size per “block”.  If one is not in a hurry to complete a transaction, one can simply offer a lower fee and wait until the higher fee offering transactions have cleared. As might be expected “miners” prioritize transactions based on the block processing fee they will earn.  

As to entry prices, Bitcoin has a typical trading bid/ask spread which fluctuates with market conditions and is not a fixed percentage cost. 

Second analyst disclosure, AA is not recommending Bitcoin as a superior investment but merely pointing out the difference in fee structure.

It should be noted that OG has ongoing operating costs regarding the storage, insurance, etc. of the physical gold that Bitcoin which is backed by air does not.  Whether its other costs are justified or not, الله أعلم 

OG’s fees may appear higher than market, but surely one can’t put a price on adherence to one’s faith.

Interestingly, OG also offers a Russian language copy of the whitepaper, but no Arabic version.  Apparently OG sees an opportunity to market to the legions of Muslim investors in the RF.