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14th March 2023 - Rally!

tl;dr

My view of why cryptos prices are rallying hard.


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$26k.


What more do I need to say.


Curious Cryptos’ Commentary – The TradFi banking collapse

First Silvergate, then SVB (Silicon Valley Bank), and, as of Sunday, Signature Bank. The first was very crypto focussed, the second very tech-focussed including some crypto clients, and the last had grown from specialisation in real estate and legal sectors to a growing business for cryptos.


Some see this as Operation ChokePoint 2, a reference to an unauthorised, illegal, and sinister initiative of the United States of Justice to investigate banks that did business with firms whose products were legal, but over which one could raise moral and ethical questions. For instance, arms dealers, and payday lenders to name just two.


You may not approve of those businesses, and if so, you are perfectly entitled to campaign for further regulation, or even outright banning of those activities.


What is not acceptable is the bureaucratic arms of governments interfering with legal and lawful business by attempting to restrict their access to financial services and providers of capital. In the end multiple lawsuits were settled against the US Government to the detriment of US taxpayers.


Some see the shuttering of these banks, and especially Signature Bank, as an attempt to deprive the crypto industry of the banking services it requires.


A popular narrative also built up over the weekend that these three bank closures might deal a fatal blow to the crypto revolution. At the very least, most commentators felt that crypto prices would suffer, and cryptos firms would fail, dealing yet more body blows to the credibility of cryptos.


Instinctively, I felt this negative narrative to be wrong.


Regular readers know that the contrarian philosophy burns brightly within the CCC research team, despair as we do of the lazy intellectual process on display by the herds of regular commentators in cryptos, and the herds of regular commentators of most other endeavours of humankind.


Let me explain why this time they are wrong, yet again.


As we discussed in the CCC on 11th March 2023, the collapse of SVB is a simple repeat of the most common cause of a bank failure – borrowing short, and lending long.


To a certain extent, banks are destined to have a significant maturity mismatch between assets and liabilities. An obvious source of bank capital is customers’ deposits which by their very nature are very short-term, even just overnight, or intra-day.


Loans made to clients will always be longer, sometimes many years.


A key role of risk management and the Treasury department of a bank is to manage this maturity mismatch.


I have read that SVB’s management were clearly at fault, with a maturity mismatch out of sync with their asset/liability base. That maturity mismatch undoubtedly existed, but the cause of this problem lies elsewhere.


Just two years ago, 10-year US Treasury yields were sub 1%. When SVB were forced to sell their bond portfolio last week (more on that in a minute) rates were around 4%. A quick and dirty calculation that doesn’t consider coupon sizes, the rolling maturities of 10-year bonds, the move away from par, the absolute level of rates, and a host of other technical adjustments that need not concern us here, leads to an estimate of a 30% loss on that bond portfolio.


It has been reported that SVB took a 1.8bn loss on the sale of more than 20bn of bonds, a loss of less than 10%. That is a superb outcome compared to a 30% loss and indicates to me great risk management.


We must look elsewhere for the root cause of the problem.


Certainly, we can start with the horrors of QE (quantitative easing), a policy designed to make the rich richer, and the poor poorer. The massive market manipulation by CB (Central Banks) worldwide to suppress government borrowing costs, allowing fiscal incontinence to embed itself within the public sector, was always going to end up hurting the private sector. SVB is just the first of what are likely to be many more examples of insolvency in both the financial and corporate sectors.


But the blame game does not end there.


Basel II, an agreed set of rules whose laudable aim is to prevent bank insolvency, has one glaringly incorrect assumption built into its very core.


Basel II states that the ratio of bank’s capital to its risk weighted assets must be no lower than 8%.


What this means in common parlance, is that the riskier the asset the more capital a bank must set aside for that asset. A most reasonable approach but it fails on one important point - government debt rated as investment grade has a zero-risk weighting, and there are some get-out clauses for sub investment grade bonds such as those issued by Greece. The headline 4.25% for 10-year GGBs is simply a reflection of the Head of the ECB’s - Convicted Criminal Christine Lagarde - attempt to prevent peripheral debt exploding with illegal bond purchases and is not a market evaluation of the real risk.


The regulatory environment for banks encourages, and even demands, that banks invest in government bonds, on the assumption they carry no risk. This is preposterous, as we saw with that theoretical 30% loss on a 10-year bond portfolio in just the last two years. That sort of potential loss takes you into speculative equity type assets, or even cryptos if you will.


The regulatory environment around TradFi banks is broken and is not fit for purpose.


One of the first responses by CBs to the GFC (Global Financial Crisis) in 2007 was to extend unlimited swap lines to regulated financial institutions. Clearly there was a financial penalty for the banks who took advantage of this opportunity to guarantee short term liquidity issues would not become terminal solvency issues, but in many ways, this is the core (and only) function of a CB - to act as lender of last resort.


Somehow, this correct application of CBs’ responsibilities morphed into QE, and swap lines were withdrawn. SVB would not have become insolvent if the US CB had stuck to its knitting.


The legislative environment around TradFi banks is broken and is not fit for purpose.


The Fed’s response, according to a journalist at a most esteemed newspaper just yesterday, is to provide a $25bn fund to access money using bonds as collateral. If swap lines had remained in place, that job had already been done, so the journalist really missed the point.


She did however continue with this comment:


“It will only work if selling pressure on US Treasuries abates …”


US Treasuries have rallied 42bps since the middle of last week, adding 4% to the value of 10-year bonds. I have pointed out to her that a price increase of that nature does match with any reasonable understanding of “selling pressure” but no response has been forthcoming. Yet again, popular commentators ignore financial reality rooted in actual prices.


I note that the journalist in question is the Economics Editor. Rarely has an expert in the field of economics ever demonstrated a grasp of financial acumen, so criticising her conflation of price increases with selling pressure may be a bit harsh.


So, the stage is now set for these three banking collapses to shine the spotlight on the issues and problems that exist in TradFi, issues and problems that the politicians have totally failed to address in the 16 years since the GFC.


BTC was invented to provide an escape route from the manipulation of fiat currencies by the liberal elite.


This is why BTC has rallied from just under $20k to over $26k in mere days, causing convulsions and paralysis amongst the staff of organisations such as the Financial Times, the New York Times, and a lot of head scratching at the HQ of Berkshire Hathaway.


But there is more!


I believe this sequence of events will make for a more benign environment for cryptos in the medium term.


The US, and the UK, are setting out a stall of antagonism towards the crypto revolution.


Meanwhile, the EU is cracking on with a crackingly great piece of crypto legislation. MiCA (Markets in Capital Assets) provides regulatory certainty for crypto businesses to invest, innovate, and develop. Though not yet in place, crypto firms are now modelling their business to comply.


Again, there is more!


France – surprisingly – has its own very welcoming crypto business application and recognition process.


The US and the UK will start to haemorrhage crypto tax dollars to the EU. Crypto firms are more mobile in terms of personnel, capital, and limited physical infrastructure than ever seen before.


To play catchup, in 1-2 years’ time, the US and the UK will have to make themselves very welcoming to crypto entrepreneurs, leading to a far more benign regulatory environment than what one might expect today.

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