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On fragile finance
Just the beginning
It’s been quite a week. In the world of central banks, the Fed pushed the overnight rate complex up by 75 basis points in a hastily telegraphed move; the European Central Bank held an emergency meeting to announce an “anti-fragmentation instrument” (!); the Swiss National Bank announced a surprise 50 basis point hike. Meanwhile in crypto-land, bitcoin and ethereum are losing air fast. Particular focus has been on crypto lender Celsius, which froze redemptions after sustaining losses on Lido staked ether tokens. Crypto exchange Binance halted Bitcoin withdrawals for a while, blaming a “stuck transaction,” whatever that means. The list goes on.
If I could take them one at a time, these situations would all be fine material for Soon Parted. But if instead I try to take them all at once, I get one simple but important idea: financial fragility.
Crypto markets are amplifying disturbances
Last month, stablecoin Terra USD collapsed when reality asked its algorithm to divide by zero. Not only did the failure erase tens of billions of dollars in paper wealth, it also put a wobble into the price of even-more-central stablecoin Tether. Tether has been trading below par ever since, not a good look for an instrument with aspirations of moneyness.
Now, Crypto lender Celsius appears to have taken big losses on its investments in Lido staked ether (stETH). These are tradable instruments that will be redeemable at par in regular ether when the ethereum blockchain completes its migration to proof-of-stake consensus. But that won’t happen until August even if “everything goes according to plan”. The plan, however, does not address the possibility that the value of ether will be zero by then. So holders of stETH have been selling in the secondary market at a discount. This led to big losses for Celsius, which was forced to suspend redemptions to its depositors. It was in the middle of this drama that Binance also suspended redemptions. The precise connection to Binance is not clear to me, but I also don’t think it matters much.
The world of crypto assets is strongly hierarchical, its aspirations to decentralization notwithstanding. One of the functions of hierarchy is to resolve problems at the lowest possible level. When a hierarchical system is working, financial disruptions at the bottom get resolved at the bottom. In both of these cases—and there will be more—we see the opposite. Terra to Tether. Lido to Celsius to Binance. Disruptions are making their way to the center.
This is what fragility looks like
These are fragile financial conditions, to use a term from Minsky: crypto markets have gotten to the point where small disturbances are amplified rather than attenuated. That in turn tells us that reserves of cash are diminishing, so that losses are transmitted rather than absorbed.
Those cash reserves are diminishing, in turn, because central banks are raising interest rates. Money, that is, has gotten a lot more valuable in the last few weeks. Those who have cash might now prefer to hold onto it; those who don’t are trying to get it, and offering big concessions to do so.
This is the immediate effect of tightening monetary policy, and it is not without drama, as we are seeing. But nothing that’s happened so far has much bearing on the price of consumer goods, which is what will tell central banks when to stop. So hang on tight.