Stuff worth knowing from The Bankers’ Plumber
“What exactly are the risks with Tether?” That question was posed to me recently by a very senior exec from one of the tech titans in FAAG. Way back, my friend mined some Bitcoin and he had recently had a rough time turning the sale proceeds into real cash in a bank.
Two other recent events make this a great time to understand whether a dollar, or a pound, will still be a pound in the DLT world:
- In the last week, the good folks at IBM have proclaimed progress with a USD backed coin.
- An announcement from the Bank of England about its recent trials in interfacing the new world of Blockchain to its payments system.
The payments side of Blockchain is really important. If we are going to realise the much talked about potential the Blockchain has to vastly improve many processes and offer new products, then it is essential that we work out a robust means of payment.
I hope you can take the time to read this post, give me some feedback and share with your friends if you think it is worth doing so.
The Tether theory goes that you give Tether your USD cash, they look after it and give you the electronic equivalent in a form you can use on Blockchain. Bingo, you now have a medium of exchange and a means of payment, fulfilling two of the four functions of money, and possibly the third, as a unit of account.
My Bitcoin rich friend explained how he held his BTC via a large exchange. When he sold BTC, there were many obstacles to his getting the proceeds into his Swiss bank account. While sorting this out, he saw that the exchange had Tether and not “real” USD on its Balance Sheet. He asked me what that meant for him. I explained that he had three levels of credit risk.
- The exchange where he held his BTC and cash; were they operating on a sound basis?
- Tether as a company. Did they really operate on a sound basis? There are good reasons to doubt this; firstly, they recently parted company with their auditor, so there is now no way to check that the $2.5B they claim to have are indeed backed 1:1 with greenbacks. On top of that, a recent article suggested Tether is vulnerable to a double spend problem. That article is over my head in terms of tech comprehension, but taken with the first, that verifying the 1:1 backing is not readily possible, the BS detectors go to overdrive.
- The bank where Tether holds the underlying USD. $2.5B greatly exceeds any deposit insurance. If the bank holding the USD goes under, even if Tether is 1:1 backed at that moment, the Tether coins are worthless. And, even if there are several banks, there are not 10’000 banks.
My criticism of Tether is whether it is store of value, money’s fourth function. A priori, the money is not 100% safe and with that, Tether does not properly fulfil the fourth function of money. Commercial banks have this same problem today; however, they are more closely regulated and in many countries there is a government guarantee or deposit insurance scheme to cover some of the cash balances.
The proposed USD-backed coin from IBM is a little better. They have worked out a means to have FDIC insurance, the US scheme that covers depositors for the first $250k in balances. The regulatory burden that goes with that will likely ensure that users can be more certain that the 1:1 backing is there.
But, and it is no small one, what IBM are doing is creating a standalone, island solution. Although they may well be successful with this offering, they will not have an absolute monopoly. By definition, there will need to be a means to exchange with other equivalent DLT offerings in USD; either directly or by returning to USD and then buying the other Crypto USD. History has something to teach us here; in times past, commercial banks issued their own notes. In the US, this practice ended in 1913.
Transferring between different issues of USD backed Crypto USD will, at the very least, create issues of timing and quite possibly transaction fees too. In the Crypto world, transfer fees aka transaction costs can vary massively too, In a recent interview, the Chief Economist of the BIS highlighted how the cost for any transfer of BTC was at $57 in December.
An added obstacle for those doing business in the new world of Crypto is that traditional banks are also making it very hard to exit aka defund from Crypto to fiat. For more on this click here.
In the banking world, the issue of transferring or settling assets between locations is sometime referred to as a “bridge problem”. In the securities world, we have long lived with the fact that a security might settle in up to three places: domestically, in Euroclear or in Clearstream. We have found ways to optimise around that, but the transfer is not seamless, and it is not unheard of that transfer agents have delays. In the cash world, the banks are very aware of the challenges created by having too many Nostro accounts. Imagine you have more than one bank account; you need to make sure that you can settle the payments you make. Banks have that challenge on a much bigger scale; the amounts are bigger, the number of accounts is larger and so too is the list of legal entities. A bank settling its securities in Euroclaear, will have multiple cash accounts there as well as at least one more correspondent for cash payments
In Switzerland, our financial markets infrastructure is really well developed. Although, we may not use the fashionable term of “rails”, the way in which the various parts interact with one central pool of cash exemplifies what I think the new digital world of DLT needs. The single pool of cash is at the Swiss National Bank and it can be used by any part of the local infrastructure.
Lessons to be Learned
The IBM proposal of a USD-backed coin is a helpful capability for those who want to use DLT. it is though, an imperfect solution and potentially creates an island that cannot easily bridge to other equivalent solutions, complicating the process of cash & liquidity management.
As the Crypto / DLT world develops a proliferation of collateralised coins and Tether like-solutions, the result is not really a great solution for users at any level. The situation would not improve if there were no collateral backing; my colleague Robert Sams has written thoughtfully on this specific area.
Evolving to a DLT solution with one central pool of funds which is 100% backed by fiat currency deposits and held as collateral in a central bank is the basis of a solution which can serve all needs and would fulfil all four of the functions of money. This is at the heart of the USC Consortium’s work. Watch this space.
My thanks to colleague and free thinker Rhomaios Ram for his generous and thoughtful input to this post.
About the Author: The Bankers’ Plumber. I help banks and FinTechs master their processing; optimising control, capacity and cost.
If it exists and is not working, I analyse it, design optimised processes and guide the work to get to optimal. If there is a new product or business, I work to identify the target operating model and design the business architecture to deliver those optimal processes and the customer experience.
I am an expert-generalist in FS matters. I understand the full front-to-back and end-to-end impact of what we do in banks. That allows me to build the best processes for my clients; ones that deliver on the three key dimensions of Operations: control, capacity and cost.
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