(This article is reproduced with authorization from Winston Hsiao, co-founder and chief revenue officer of XREX )
In just one week, two American banks, Silvergate Bank and Silicon Valley Bank (SVB), were in crisis one after another. It also happened that Silvergate Bank was relatively friendly to the cryptocurrency industry, and SVB is the world’s main Stablecoin USDC. One of the banking partners of the issuer Circle, many people misunderstand this crisis is from cryptocurrency to traditional finance, in fact it is the complete opposite, not only that, this is a systemic crisis of banks, the worst case scenario is likely to be Panic, run, followed by a series of bank explosions.
We have received many inquiries from investors, users, and relatives and friends around us. What we need most now is rationality, because the market is most likely to lose control under irrational conditions, and the worst situation that could have been avoided is inevitable. Therefore, I hope to use this somewhat long post to explain the ins and outs of the matter, and how blockchain financial institutions like XREX exchange evaluate, analyze, deduce and respond.
The collapse of Silvergate and SVB, what alarm bells ringing?
First of all, I must say that the current crisis that is still burning is very pessimistic, and I have deep worries in my heart, and Silvergate and SVB must not be the only two, I think that many commercial banks are facing the same There is a great possibility that we will see more and more banks encounter difficulties one after another, triggering a domino effect, which we do not like to see.
As the co-founders of the XREX exchange, even though we have no exposure in Silvergate and SBV, we have, as usual, made the most extreme assumptions and sand table deduction based on the information we have from all parties, and have activated all necessary layers Risk control measures. To be honest, the biggest headache for us at the moment is not to deal with the existing information that everyone sees in the news or the market, but to think about how we, as exchange operators, should deal with the worst situation if things really turn out to be the worst. Maintain services and operations? And to ensure that user assets are best protected?
As I said at the beginning, the main reason for the crisis of Silvergate and SVB banks is not in the cryptocurrency industry. What is the main reason? It is the risk control and asset allocation of traditional banks, and what directly affects all of this is the crazy interest rate hike by the US Federal Reserve in the past year.
I once said in the previous podcast [Web3 Great Westward] that finance is finance, and it does not make a difference whether it is traditional finance or blockchain finance. This crisis is closely related to everyone. I have a background in economics, so before I start explaining this, I would like to quote two famous quotes from two economists of different schools, one is Adam Smith of the classical school: "invisible hand" (invisible hand); One is what Keynes of the Keynesian school said: "In the long run, we are all dead".
The above two sentences subtly explain the contradictions we encounter at present, the struggle and balance between "free market" and "government intervention". This article is not written for the blockchain industry, but for a cause and effect that all of us must be highly alert to, as well as the impact of all of this on tomorrow's finance and economy, and the cryptocurrency industry is just one of the roles.
The market mechanism is the invisible hand
Adam Smith advocated that under the condition of perfect competition, the economic operation does not need government intervention, because government intervention is not a natural product, it may temporarily solve the current problem, but it does not cure the root cause. Everything should return to the free mechanism of the market. The classical school believes that as long as market information is completely transparent and free, producers and consumers will pull each other in order to maximize their own interests, and all supply, demand and prices in the market will rely on the "invisible hands" of the market mechanism To control and balance, so that all resources are fully and properly distributed, and then achieve the goal of national prosperity.
Economic Crisis Needs Active Intervention of Fiscal and Monetary Policies
Different from the classical school, the Keynesian school headed by Keynes believes that as long as we encounter an economic crisis, the government should actively intervene and use its fiscal policy and monetary means to intervene. Although this creates a budget deficit during the intervention process, if the problem is solved, the tax revenue will increase and the deficit problem will naturally be solved.
This is why Keynes has the famous saying "In the long run, we are all dead". He believes that letting the free market to achieve self-healing may be less sequelae, but it will make people suffer at the moment, and everyone is Live in the present, and each of us will be dead in the long-term future. Therefore, the function of government is to focus on solving the economic crisis we are facing now.
Market mechanisms and government intervention are always an inconclusive tug-of-war, but since the global financial crisis in 2008, we have seen a sharp increase in government intervention. The unprecedented large-scale money printing campaign has launched, and this dose of strong medicine cannot have no side effects. Until now, we are discussing that the crisis of top students in banks like SVB without warning is related to these things.
Only when we look back at the roots of yesterday can we know what we really experienced today and what kind of tomorrow we will face.
The Roots of the Crisis: From the 2008 Global Financial Crisis
The crisis of Silvergate and SVB banks, I think we have to start from 2008. At that time, the linked debt detonated by subprime mortgages caused the most serious world economic crisis since the Great Depression in 1929. Lehman Brothers, Merrill Lynch, Bear Stearns and many other long-established banking giants encountered Liquidity crises one after another. Bankruptcies, takeovers were taken over, takeovers were acquired, and the global financial order collapsed instantly. The shock caused by Iceland's national bankruptcy crisis is still vivid in my mind.
It is against this background that the government decided to intervene vigorously with fiscal policy and monetary means. The general means of regulating the economy is to give priority to finances, that is, the government will "increase government expenditure" and "reduce taxes" as the guide, and if it is not effective, it will resort to monetary policy. Using monetary policy to regulate the economy is nothing more than two major means of "adjusting interest rates" and "money supply". Since 2008, these should be familiar terms to everyone. Whether the Fed will be dove or hawk, how many yards and speed of interest rate hikes will affect the stock market, foreign exchange market, currency market and various market reactions.
From shallow to deep, even the most influential US government in the world can achieve the most extreme intervention, nothing more than the following four points:
- Injecting an unlimited money supply into the market
- Randomly adjust the interest rate between two extreme values between 0 and infinitely high
- Act directly as a market maker for credit and asset market transactions
- Unlimited borrowing
We have all witnessed the above in just a few years.
The two monetary quantitative easing (QE) policies in response to the 2008 financial crisis achieved a hemostatic effect within a certain range, but they also opened the Pandora's box of QE, a dangerous weapon. In essence, QE is to inject massive money supply into the market and directly lower the interest rate to close to zero. As long as it is not properly controlled, it is likely to cause hyperinflation.
Fortunately, the implementation of the first two QEs not only achieved their goals, but also did not detonate high inflation. This was the best time to exit and deal with the aftermath. The funds flooding the market could be recovered gently and the market should return to its proper mechanism. Unfortunately, the government's tastes coincided with the election, and the two QEs did not have soaring inflation, which emboldened them. In September 2012, they insisted on implementing the third QE, which is still full of controversy. Human calculations are not as good as the sky. In 2019, the new crown pneumonia broke out that no one had ever expected.
COVID-19 shuts down economy instantly
The third QE launched by the United States due to the new crown pneumonia is doomed to be a failed gamble. Originally, the wishful thinking of the United States was to use QE to reverse the high unemployment rate and accelerate domestic economic growth. As long as the international economy recovers, the financial market will be active, the unemployment rate in the United States will be effectively reduced, and everything will return to prosperity.
This decision really worked in the early stage. The United States also began to deal with the aftermath of the third QE, but the new crown pneumonia brought the global economy to an instant shutdown. The karma accumulated by the three QEs was like the tide receding and it was too late to wear clothes. We had to bite the bullet and implement the fourth QE, to avoid a full-blown economic collapse.
QE went from mild aftermath to bloodshed
The four consecutive QEs have led to a serious flood of funds in the financial market, and signs of inflation have begun to appear. If the funds are not recovered effectively, it may evolve into hyperinflation that is difficult to deal with. This is also the beginning of our transition from "crazy money printing" to today's "crazy interest rate hikes". In March 2022, the U.S. Federal Reserve will aggressively start raising interest rates, simultaneously releasing a message to the market that "there will be no limit to raising interest rates until the problem is resolved."
Looking back on the past less than a year, the Federal Reserve has raised interest rates 8 times by a total of 450 basis points (25 basis points are one yard), pulling interest rates from close to zero to close to 5% in one breath:
- 2022-03-17 : Raise the interest rate by one yard to 0.25%~0.5%
- 2022-05-04: Raise interest rates by two yards to 0.75%~1.0%
- 2022-06-16: Raise interest rates by three yards to 1.50%~1.75%
- 2022-07-28: Raise interest rates by three yards to 2.25%~2.5%
- 2022-09-22 : Raise interest rates by three yards to 3.0%~3.25%
- 2022-11-03: Raise interest rates by three yards to 3.75%~4.0%
- 2022-12-15: Raise interest rates by two yards to 4.25%~4.5%
- 2023-02-02: Raise the interest rate by one yard to 4.5%~4.75%
Unlimited QE means unlimited borrowing
In order to have unlimited QE, the Federal Reserve must purchase treasury bonds or corporate bonds to allow banks to increase funds in the settlement accounts opened by the central bank, thereby injecting more funds into the banking system. The U.S. national debt has reached the legal limit of 31.38 trillion in January this year, and Congress is currently promoting the "elimination of the debt ceiling" and warned that if it is not passed, the United States will not be able to fulfill its obligations and increase the probability of default. Banks are the most important part of the government's overall financial and monetary policies, and they also directly participate in the bidding of public bonds. Of course, they have to take on the role of coordinating governance. From here, is the Silvergate and SVB bankruptcies we see today.
National debt and interest rate hikes put enormous pressure on commercial banks
Commercial banks are different from investment banks. The business focus of commercial banks is to absorb user deposits, provide interest and use funds to issue loans, which is also the core of the money market. In other words, the main profit of commercial banks is the "interest spread" between deposits and loans rather than investment. Under such a profit model, the assets and liabilities of commercial banks are mainly user deposits. In order to meet the needs of surviving users to withdraw at any time, a certain proportion of Liquidity assets must be maintained.
Generally speaking, commercial banks do not invest in long-term bonds. However, the Federal Reserve raised interest rates crazily, and the market demand for loans increased sharply. The pressure of interest not only increased the cost of banks, but also increased the risks of enterprises, mortgages, and credit. Under such circumstances, long-term treasury bonds have an attractive As interest rates increased, commercial banks began to shift their positions to long-term treasury bonds.
Most of the time, government bonds are still highly liquid and low-risk, but they will be subject to "interest rate" constraints. When the market interest rate rises, the price of the bond will fall, and the longer the duration, the more the price will be affected by the bond yield. The Fed's unprecedented speed of raising interest rates has officially led to the bankruptcy of two major banks, Silvergate and SVB.
Of course, we can say that this is also the bank's improper risk control, and it did not properly use the interest rate swap contract (IRS) to lock in the bond interest rate. However, most of the bank's investment and risk control are based on historical data. The Fed's extremes have no experience to speak of, and judgment deviations are inevitable. What's more, this accident is not a bank with extremely poor credit ratings and past performance. , but traditional financial top students like SVB.
Silvergate and SVB have a lot of long-term bonds, which defies common sense
According to Silvergate's report, up to 80% of their deposits have been used to buy long-term bonds. Surprisingly, most of them are bonds with a maturity of more than 10 years. SVB's available data shows that they sold all available bonds, worth $21 billion, and recognized a loss of $1.8 billion, mostly US Treasury bonds.
In all fairness, this is against common sense, especially the tragedy of Silvergate, any professional banker with a little common sense would not have such an operation, not to mention that Silvergate is not a bold bank in nature.
It is also because U.S. government bonds can be recognized by the method of holding to maturity (Hold to Maturity, HTM), and there is no need to recognize losses by market value in the quarterly financial report. Therefore, in Silvergate's strategy, as long as the user's withdrawal and transfer can be ensured to run smoothly, that is, Liquidity management is done well, higher rewards can be obtained through long-term debt.
However, this wishful thinking was overwhelmed by the crazy interest rate hike, because the interest rate hike put pressure on corporate customers, the Liquidity of user deposits became higher, and the default rate of loans released also increased. A series of blows forced Silvergate to sell these HTM The bonds were realized and repaid at the market price, and they were forced to recognize losses in an instant. In the end, they could not produce financial reports as they did, because the losses on the accounts had accumulated to the point that they had to declare liquidation and bankruptcy.
Is all this caused by the cryptocurrency industry?
From the previous discussion, everyone should be well aware that the crisis of Silvergate and SVB has no direct relationship with cryptocurrency. It should even be said that the cryptocurrency industry and many other companies that store their money in these two banks are the same as individual households. is a victim.
Although the collapse of FTX, the world's second largest exchange, caused many people to sell cryptocurrencies in panic, and even exchanged Stablecoin back to US dollars, which indirectly caused a run on banks, but this is the most known cryptocurrency when banks undertake related businesses. Industrial characteristics. When the market is stable, the cryptocurrency industry also creates the most stable source of deposits for these banks, and many even need to pay the bank's high management fees.
It is a pity that when such a crisis broke out, many public opinions pointed the source of the crisis to the cryptocurrency industry. First, they did not have much understanding of the global financial changes since 2008, and second, they misunderstood and prejudiced the cryptocurrency industry. In this crisis, USDC issuer Circle faced huge market pressure because it was one of the depositors of SVB. However, the instability of USDC in the past week was actually caused by bank problems. On the other hand, as soon as Silvergate was liquidated, many people immediately named it a "cryptocurrency bank". This is not only unfair to the cryptocurrency industry, but also prone to misjudgment of the financial crisis that is still spreading.
Now, what can the cryptocurrency industry do?
From a purely macro perspective, I would like to appeal to everyone not to FUD (Fear, Uncertainty, Doubt, that is, fear, doubt, doubt), because we know very well that this crisis comes from traditional finance, and the cryptocurrency market has been affected. But because we are also part of the global economy and finance, it is impossible to be completely isolated.
If you want to throw away the Stablecoin USDT and USDC at hand for the purpose of hedging or because of fear, you can exchange USDT and USDC for mainstream cryptocurrencies such as Bitcoin or Ethereum if conditions permit, which can reduce Circle The two Stablecoin issuers, Tether and Tether, have to deal with the pressure of redemption, otherwise they will be forced to run on the bank in an instant. As I mentioned at the beginning, I believe that many commercial banks are facing difficulties to a certain extent, and what I really don't want to see is a thrilling chain of bank explosions.
This time, the bankruptcy crisis of Silvergate and SVB is different from the previous incident of FTX exchange. The source of the problem is not USDT and USDC, but because traditional banks have encountered systemic risks and have been affected. I myself am an exchange operator and a believer in blockchain technology. Of course, I don’t agree with the troubles caused by banks today, but I believe that both Circle and Tether are already actively dealing with it, but what they can do It's really limited, and the bank's assets are still there, it just takes time for space.
The problem this time is definitely not unique to banks that are friendly to the cryptocurrency industry, but a large number of U.S. commercial banks have done the same thing. This is a systemic problem. Although commercial banks are the front line, they also need to bear the most direct responsibility, but the collapse of the overall system is the biggest problem. I believe and hope that the government will take correct and immediate actions, because we really cannot afford it. We need rational, correct and fast government actions before the bank explosions.
