The Money Lego is ok.

On Tether’s peculiarities.

Part of this article is written by AI.

There are people (myself) who like to point out that DeFi products are, in fact, already existing just under a different name in the world of traditional finance. They especially like to call the DeFi solutions (decentralized exchanges, insurance pools, synthetic derivatives) unnecessary alternatives to safe and institutionalized solutions, and yes, they admit that DeFi might be offering a (much) higher return right now, but that’s thanks to their ponzi-like nature.

Their second favourite thing is to talk each week about some new pet coin ripping, either without a reason or due to a very bad reason. Why does the SHIB coin go up when Elon Musk tweets about getting a Shiba Inu dog? And just stop me here and tell me that it is very obvious what is happening with the SHIB coin and I would agree. Tell me that there is absolutely no qualitative or financial relationship between the wellbeing of Musk’s dog and the coin, but the tweet works as a trigger point for people to (very) short-term speculate that the price will go up. Because that is what people like to do for fun now — trade like it’s a casino.

But what about the “DeFi is unnecessary” claim?

We like to write here again and again that although debt leads to excesses and a boom-and-bust, it is essential for human economic activity because: 1. it transfers means from the haves to the have-nots, but also (and admittedly this is more controversial) because 2. it turns repayment into a fluid concept; there is always the option to extend, roll-forward or renegotiate terms. Ok, yes, so it wakes up the animal spirits; people are less worried to be entrepreneurs with borrowed money.

What we don’t write about here at all is the other magical power of finance. You can transform things that would be hard to sell into things that investors want. This is how it works (and yes credits to Matt Levine here): generally speaking, there are people that want to invest money they cannot lose and people with money that they want to, like, double in value and they are ok with much more risk. If you’ve got an investment that is ok, but not high-yielding or super-safe, you will find some buyers. If you slice it to super senior and super-risky junk tranches you will find many more buyers.

Say that investment is worth $100 right now. You slice it into a super-risky junk tranche that you sell for $50 and a super senior tranche that you sell to safe investors for $50. If the investment goes to $200, the super senior tranche gets $51 and the junk gets $149. If it goes to $50, the super senior tranche still gets $50, but the junk gets $0. The junk investors covered the senior investors.

You can add several layers of slicing, of course. Like some of your buyers might slice their junk tranche into senior and junior tranche CDO. And their buyers could slice it again into senior and junior tranche CDO-squared.

This IS the magic of finance .. transforming risky things into completely safe money (because junk investors cover the downside). And, sure, you could say that this is great and that this fuels economic activity. The ability to sell anything (which at its core will always be just future cash flows of risky businesses) — after sufficient slicing and tranching has been applied — transfers money from the haves to have-nots .. and animal spirits and so on…

But just like “real” magic, isn’t it also a bit scammy? Like, the things sell when sliced and tranched partly because it is a bit opaque and confusing and slightly harder to say what is worth what?

Anyway, I feel like this is also the main beef that traditional finance people have with DeFi. That it is cryptic and confusing, spurring short idiotic speculation and leaving people with uninsured losses.

It feels like a lazy argument?

We talked here about how DeFi is rewriting Wall Street into a code, and for now, yes, its mostly exciting because it offers unsustainable rates of return based on the ponzi-like nature of many DeFi projects offering liquidity mining rewards, but the elements of absolute automation and decentralisation have to be worth something? I stop here to avoid writing one more pollyannish essay about the bright future of crypto, but really it is absolutely cool that there are automatic exchanges, insurers and lenders that you can be a co-owner in, and with the same risk-return profile that a large institution would be in the traditional finance because there is no hierarchy, just code.

And two things are happening:

• In financially and regulatory less sophisticated parts of the world like South East Asia, crypto and fintech products have real customers and they are flourishing because there are fewer rules about what is a bank or a what is a lender; there are fewer old regulatory boxes that people are trying to wedge crypto into.
• In Western world, the lazy argument of “we already have a box for that, let’s regulate it by those rules” has the power and it distorts the growth of some crypto companies. Bloomberg’s latest article “Anyone Seen Tether’s Billions?,” picks easy targets, joking about Tether founder’s ex-plastic surgeon career or the graphic offices of Bahama banks, but really, its conclusion is that a company, whose product is seeing 15-fold growth from $4B in March 2020 to $61B in May 2021 has been ostracized and pressed to store and invest its immense assets outside of the bankable environment. As Matt Levine points out, the most likely scenario is that Tether lends its money to crypto-lenders, who lend people money against bitcoin as collateral. With the rise of the bitcoin over the past 1.5 year, you can see how this could have mopped up a lot of Tether’s assets.

You can also see how it could have a downward spiral on the entire crypto market.

If Tether’s always-worth-a-dollar value came from the value of senior claims on levered Bitcoin positions, rather than from Treasury bills etc. — if the value of Tether comes in essence from people’s confidence in the value of Bitcoin — could a strong wind blow the whole thing over?

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