Never a Dull Moment
Sango Coins, Decentralized Lending, Contagion and More!
I am on vacation this week, but few things are more fun than writing this newsletter so rather than a deep-dive, here is general commentary on the state of play in crypto 😎✌️. Forgive the emojis. I am in a good mood.
Sango Coin
Take the United States. Axe GDP per capita (PPP) in half and you get Greece. Slash average living standards in half again and you get China. Cut them in half again and you get El Salvador. Halve them a fourth time and you get Congo. Slice them in half a fifth time and you get Sierra Leone. Slash them in half one last time and you get…
The Central African Republic, the second country after El Salvador to adopt Bitcoin as legal tender where about 80% of the population does not have internet access. President Faustin-Archange Touadéra was embraced by the Bitcoin community with open arms thanks to his crypto policy but it looks like he’s … not so loved anymore (more later).
The President recently announced he is creating a ‘crypto hub’ and launching a national crypto currency, Sango Coin, that will be backed with / used to invest in the country’s mineral resources, or something like that. I’m not a CAR expert, but a cursory reading of the news suggests that the primary constraints to resource extraction and economic growth in that country are related to ongoing civil strife and political instability, not the currency.
The most generous reading, I suppose, is that this will function as a voluntary, progressive tax. Voluntary, because no one will be forced to buy Sango Coins. Progressive, because only (relatively) rich people with internet access will be able to buy them. And a tax, because eventually the coins will be worthless, making the purchase a straightforward transfer to the government.
Anyways, Bitcoiners are upset. Sango Coins are not Bitcoins! Treason!
Contagion
Crypto banks that take deposits and make loans have continued to blow up. First it was Celsius, a $12B asset manager that stopped withdrawals in the aftermath of the Terra/Luna collapse and Three Arrows Capital (3AC) collapse. Then it was BlockFi, a supposed blue chip industry standard crypto lender, which also paused withdrawals and has since been bought by crypto exchange FTX.
Over the weekend, a publicly listed company that paid interest on crypto deposits named Voyager also froze withdrawals and most recently, Vauld also froze withdrawals. A key OTC crypto trading desk suggests several shoes are yet to drop, with more losses for retail investors.
There are several problems with offering yield to customers (depositors) like a bank. First, these companies are not banks and don’t take basic measures to protect depositors like banks do. For instance, they don’t have much 🌷equity🌷 on their balance sheets to cover losses from bad investments and bad loans. They also don’t take out 💃insurance🕺 to protect deposits against bankruptcy.
Second, they don’t appear to have basic risk management practices, like diversified loan books and limits on exposure to specific industries and counterparts. All these (quasi) banks lent essentially ✨all their money✨ to other crypto ventures. And most of these (quasi) banks that are distressed or insolvent lent out a significant share of their assets to ✨a single✨ debtor, 3AC, which took out many of its creditors when it blew up.
Third, they seem to have invested some fraction of depositor money in overt or disguised pyramid schemes to generate yield to pass on to depositors, after taking a cut. These way-above-market yields were not based on real world economic activity (they never are) and eventually led to large losses (as they always do) when market conditions turned around.
CeFi vs DeFi
Crypto Twitter argues that the institutions that failed are managed by human teams and discretion, not automated protocols on the blockchain and are thus Centralized Finance (CeFi), not decentralized finance (DeFi). This distinction is invoked to point out that it’s CeFi that failed, not DeFi. This is both 🎵true and irrelevant🎵.
The big automated protocols written with “smart contracts” on the blockchain like Aave (overcollateralized borrowing and lending) and Uniswap (decentralized exchange), did continue running uninterrupted and without any losses throughout the meltdown.
The problem is, these actually decentralized on-chain protocols don’t serve much of an economic purpose. DeFi continues to mostly fund unproductive economic activities, particularly leveraged speculation on cryptocurrencies.
After two years of 🚀innovation🚀, this is perhaps the most compelling use-case for DeFi: If you want to borrow synthetic dollars (USDC or USDT) against your Bitcoin or a high-value NFT or any other volatile crypto asset, you can. You just need to post 2-5x as much collateral. Want $100? Please post $200-500! Don’t have them? Sorry 😂
This is useless for most people. It’s really only interesting for crypto rich investors that don’t want to cash out their investments to avoid tax events or because their holdings are not liquid. Economically useful lending is largely unsecured, or uses collateral in the real world (e.g. real estate), but for reasons I won’t get into here, that hasn’t and (won’t) get built to scale on blockchains.
Capital Controls / Cross Border Frictions
Last week, I wrote about the main non-speculative, non-ponzi use case for crypto and argued that it’s in high inflation emerging markets, not the developed world. The use case is just buying and holding stablecoins as a partial hedge against inflation in the local currency in places like Iran, Turkey, Lebanon, Nigeria, Zimbabwe and Venezuela.
There’s a distinct but related use case in many of those same countries: bypassing capital controls and reducing cross border frictions. In various pockets of the developing world, sending money abroad is illegal or highly restricted. Usually, because the government is broke and needs dollars to pay for imported goods or foreign bonds and wants to keep all the dollars in the country to do just that.
But once you buy USD stablecoins (or bitcoin) in a P2P marketplace, you can keep them in your wallet on the Ethereum or Tron blockchain out of the government’s reach. You can also send them to anyone in the world for a small fee, regardless of capital controls and the hassle of wire transfers1.
Look at Argentina. After the abrupt resignation of their Economy Minister, it looks like sovereign default and an economic crisis are (once again) imminent. Understandably, Argentines want to convert their pesos into dollars. So they are, mostly in the black market but in part with crypto!
There, the rationale for buying stablecoins is twofold. First, to dodge current and expected inflation and FX depreciation. Second, to put money on a (borderless) blockchain out of the Peronist government’s reach.
El Salvador
Everyone keeps dunking on President Bukele for buying $107M in Bitcoin that is now worth just $58M. I get it! The supposed portfolio is down 54%! Anyway, nobody knows where the coins are, what government entity is funding the buys or if they’re even real. All there are so far are tweets 💘💘💘…
As much as I enjoy making fun of dumb things in crypto, the important thing is NOT the $50M in paper losses, which are about 0.6% of the 2022 budget and are small compared to the estimated cost of the bitcoin rollout ($375M). The important thing is that the country is sleepwalking into bankruptcy in the next few years, risking a banking crisis, and has no apparent plan to avoid it.
El Salvador can’t finance the ~$1.5B fiscal deficit paying the eye-gouging interest rates that bond markets are demanding. But rather than cutting spending, raising taxes and getting an IMF program, the plan is to continue tweeting about Bitcoin and ignoring this fact. THAT is what matters.
Some stable, well managed economies with low inflation like China also have capital controls as part of a broader policy (in China’s case, to manage the exchange rate and keep the yuan from getting too expensive for exporters). So if you want to get money out of China, it can be impossible or fraught with frictions depending on whether and what kind of corporation or person you are. Crypto (especially stablecoins) lower these barriers, particularly for individuals. That’s also a non-speculative, non-ponzi use case!