What happens when collateral becomes liquid?
While the past year was a tough one for the public crypto markets, talented and dedicated teams spent it heads down, shipping what appear to be some of the building blocks of a truly open financial system. As a result, while 2017 was the year of the ICO and 2018 was the year of continued massive private token sales, 2019 is shaping up to be the year of Open Finance.
Most significantly, Maker, which launched at the tail end of 2017, has created a system for minting a USD-denominated stablecoin (DAI) using Collateralized Debt Positions (CDPs). The system has performed incredibly well, with DAI smoothly retaining the dollar peg and CDPs sucking up >2% of all ETH, during a year in which ETH declined as much as 94% from its all-time high.
Maker isn’t the only way to borrow or lend cryptoassets. Dharma allows users to request or offer loans for any ERC20 (fungible) or ERC721 (nonfungible) asset, dYdX enables derivatives and long/short margin trades, and Compound offers money market borrowing/lending for ETH, DAI, and a handful of other tokens.
Decentralized exchange (DEX) protocols (e.g., 0x, Kyber), are now functional, as are 3rd party exchanges and interfaces to access them (e.g., Radar Relay, Easwap), allowing non-custodial trading to become a viable reality, though liquidity is still somewhat lacking across the board. In November, a new completely on-chain DEX launched that makes it possible to provide liquidity and earn fees automatically using basically the same approach as Bancor, but simplified to remove the unnecessary token. Hello, Uniswap!
We now have (almost) fully decentralized options for borrowing, lending, and trading cryptoassets, creating derivatives around any asset or event, and even a USD-denominated stablecoin that allows risk-off positions and greatly improved UX without ever needing to directly touch that dirty, dirty fiat.
One of the core tenets of Open Finance is that of permissionlessness. But if there are no gatekeepers, then how can we be sure that a borrower won’t default on a loan or that a derivative will pay out as intended?
In a nutshell: collateral is posted as a form of insurance for the other participants in the system, so that you can be trusted to take certain actions without anything else being known about who you are, where you live, how competent you are, and so forth. If your actions ever come close to harming the system, you are automatically booted out and some or all of your collateral is handed over to more responsible parties.
In the Maker system, in order to borrow dollars in DAI, you must lock more than 150% of the equivalent value in ETH in a CDP. If your collateral ratio ever drops below 150%, a “Watcher” will step in, and *POOF* — your collateral is liquidated at a 13% penalty to repay your loan. Compound and Dharma employ similar structures to ensure lenders don’t need to be worried that borrowers won’t repay their loans.
Naturally, builders and participants in the Open Finance ecosystem have tended to think of assets used as collateral as just that: assets in use as collateral. Those assets may eventually be released and used for other purposes once a loan is repaid, but for now, their raison d’être is to be collateral.
But what if it doesn’t have to be that way?
There are currently over 2 million ETH locked in Maker CDPs, generating around 78 million DAI. That means at current prices, more than half the ETH in CDPs isn’t even technically required for collateral. It is a completely dead, unproductive asset.
Sowmay Jain, founder of InstaDApp, recently proposed automating the process of sweeping excess ETH out of CDPs and into Compound’s money market protocol to earn interest (the process of moving ETH back to the CDP as needed would also be automated, of course). That is a great first step and one that is relatively straightforward to implement by integrating the Maker and Compound protocols as they exist today.
But what about the rest of the ETH that is sitting in the CDPs, ensuring that they meet the minimum 150% collateral requirement? Why couldn’t that also be sitting in a Compound money market, available for others to borrow and earning the current 0.27% APR?
While a single unit of ETH can’t literally be in two places at once (one of the primary breakthroughs of Bitcoin was in solving the “double-spending problem”), there’s no reason why deposits into Compound couldn’t be made through a “deposit token” contract, which issues an equivalent number of “Compound ETH” or cETH (or cDAI, cREP, etc) ERC20 tokens. These cETH tokens would always be redeemable 1:1 for ETH in Compound. Ryan Sean Adams points out the same approach could be used in the future by staking pools with staked ETH.
Given this reliable, transparent backing, once Multi-Collateral Dai is shipped, it’s not hard to imagine that cETH could be added as a supported collateral type for Maker. Especially with speculation that much Maker activity today is driven by ETH holders who are looking to go long with leverage, it makes sense that there would also be demand for earning interest on the ETH that sits as collateral.
cETH is a fairly basic example of liquid collateral, but what if liquid collateral was actually used to provide… liquidity?
Uniswap is a fully on-chain decentralized exchange. Rather than maintain an order book, Uniswap uses liquidity pools and an automated market maker to determine the price at which an asset can be traded. If you want to supply liquidity to the exchange and earn a proportional share of the 0.3% fee charged on every trade between a given asset pair, you just deposit an equivalent amount of ETH and the relevant ERC20 token. (If you want a deeper explanation of Uniswap, check out Cyrus Younessi’s excellent overview.)
The ETH/DAI pair is currently the second deepest liquidity pool on Uniswap. Both assets are also available on Compound. It would be great for anyone providing ETH/DAI liquidity on Uniswap to also earn interest on their assets by having them simultaneously available on Compound for borrowing. Again, the cETH-type trick would work here for half the equation (cDAI), but it feels like there’s potential to do a more direct integration or re-writing of the two protocols to make this possible.
A different trick with Uniswap that definitely works is using the liquidity pair itself as collateral (e.g., ETH/DAI, as opposed to each of the assets in that pair, ETH and DAI). What does that mean? Well, although most Ethereum wallets don’t show them by default, whenever you deposit liquidity into a Uniswap pool, your share of that pool is actually represented by ERC20 tokens.
Any system willing to accept as collateral both assets in an ETH/XYZ pair should also be willing to accept the corresponding Uniswap pool shares as collateral. Uniswap’s automated market maker function ensures that the combined value of the ETH/XYZ pool share will never drop more than either of those two assets. In fact, all else equal, the value of the ETH/XYZ pool shares will rise over time, based on earnings from trading fees being added to the liquidity pool.
I predict we’ll see Uniswap pool shares used as collateral for millions of dollars in loans in months, not years.
Anyone familiar with the world of prime brokerage services will immediately recognize the process described in the preceding sections as forms of rehypothecation: a lender taking an asset posted as collateral by a borrower, and using that same asset as collateral to take out another loan. Except in this case, we may see collateralized collateral collateralizing collateralized collateral… and so on and so forth. Oy.
This creates a daisy-chain situation: if there’s a failure at any link along the chain, all of the assets further down the chain will also fail, but anything further up (i.e., closer to the original underlying collateral) should be fine.
However, it’s extremely unlikely this chain of collateralization would be created in a neatly serialized fashion. All available evidence suggests that financial engineers will slice, lever, mix, and sling every imaginable asset in every imaginable combination to create new products they can sell to each other or the unwashed masses. It will probably end up looking more like this:
Is this really any worse than the legacy financial system? Probably not. Technically, this would all be publicly viewable and auditable, rather than hidden behind a series of closed doors and incomprehensible legal contracts. We should be able to devise systems to track and quantify risk when everything is linked together via public ledgers and immutable automated contracts. We should be able to self regulate, put in place reasonable standards, and refuse to interact with contracts/protocols that don’t demand conservative margins and ensure the collateralization chain doesn’t go more than a couple layers deep.
But given what we know of human nature, do you really think we’ll show restraint when the possibility exists to earn an extra point of yield or pay a slightly lower rate on a loan?
There is something undeniably compelling about all of this. If assets can be allocated for multiple purposes simultaneously, we should see more liquidity, lower cost of borrowing, and more effective allocation of capital. Most of the builders I’ve met working on Open Finance protocols and applications are not looking for ways to wring a few extra bips (basis points, not Bitcoin Improvement Proposals… sorry) out of the system; they’re trying to build the tools that will ultimately make every imaginable financial asset, service, and tool available via open source software on the phone of every person on the planet. Maybe we’ll never get there, but based on the hyperspeed pace at which this industry is evolving, if this is all a big terrible idea, at least we’re likely to figure that out while it’s still only a few million nerds losing their shirts, rather than causing the entire global financial system to crash and burn.
In the meantime: superfluid collateral, anyone?
Craig Wright Sues Bitcoin Developers Over Stolen BTC Worth $5 Billion
The self-proclaimed Satoshi Nakamoto, Craig Wright, has filed yet another lawsuit within the cryptocurrency industry. This time, he has targeted the developers of BTC, BCH, BSV, and BCH ABC requesting that they retrieve access to BTC stolen from his personal computer worth about $5 billion.
CSW Sues BTC Developers Because he was Hacked
Wright has publicly claimed that he is the person behind the Bitcoin network for years – Satoshi Nakamoto. This narrative, which lacks any conclusive evidence, has been highlighted once more by the latest law firm that will represent him in his most recent lawsuit against representatives of the cryptocurrency space.
Ontier, a UK-based litigation law firm, has published a press release asserting that it has informed the developers of Bitcoin (BTC), Bitcoin Cash (BCH), Bitcoin SV (BSV), and Bitcoin Cash ABC (BCH ABC) of the lawsuit.
With these “ground-breaking legal proceedings,” the firm acts on behalf of Tulip Trading Limited (TTL) – a Seychelles-based company with a primary beneficial owner – Craig Wright. The nature of the lawsuit is somewhat controversial, to say the least.
“In February 2020, Dr. Wright’s personal computer was hacked by persons unknown and encrypted private keys to two addresses, which hold substantial quantities of Bitcoin belonging to TTL, were stolen. These assets were, and continue to be, owned by TTL. The theft is the subject of an ongoing investigation by the Cyber Crime division of the South East England Regional Organized Crime Unit.”
Consequently, the lawsuit has requested that the developers “enable TTL to regain access to and control of its Bitcoin on the grounds that they owe Bitcoin owners both tortious and fiduciary duties under English law as a result of the high level of power and control they hold over their respective blockchains.”
Per their estimation, the sizeable amount has a value of over £3.5 billion or about $5 billion.
More to Follow?
Paul Ferguson, a Partner at Ontier, commented that Wright, the supposed creator of BTC, has “always intended Bitcoin to operate within existing laws.” Moreover, he believes that the Bitcoin developers have the power and obligation to deploy code to “enable the rightful owner to regain control” of his assets.
Should Wright’s lawsuit succeed, others in a similar position could follow suit, added Ferguson.
Craig Wright is no stranger to initiating lawsuits against crypto industry representatives. In his previous one, his lawyers requested two Bitcoin-related websites to remove the BTC whitepaper, which received quite adverse reactions from the community.
Featured Image Courtesy of TheConversation
All of the Federal Reserve’s wire and ACH systems are down
All of the services available through the Federal Reserve’s online portal have been down for more than an hour.
According to the Federal Reserve Bank Services’ website, the bank is experiencing a disruption in its account services, central bank, Check 21, check adjustments, FedACH, FedCash, FedLine Advantage, FedLine Command, FedLine Direct, FedLine Web, Fedwire Funds, Fedwire Securities, and National Settlement — all services typically available — which started at 6:18 PM UTC today. In addition, all the access solutions that the Fed offers, with the exception of FedMail, are also offline.
Washington Post reporter Rachel Leah Siegel reportedly received an alert from the Fed saying its staff were “currently investigating a disruption to multiple services” and would “continue to provide updates as soon as they are available.”
“A Federal Reserve operational error resulted in disruption of service in several business lines,” said Jim Strader from the Federal Reserve Bank of Richmond. “We are restoring services and are communicating with all Federal Reserve Financial Services customers about the status of operations.”
This story is developing and will be updated.
Why it’s critical to monitor Bitcoin miners’ position over the next 2 weeks
The narrative of a bear-led correction is always around, even during the headiest of bull runs. A similar situation is unraveling at the moment, with many still expecting Bitcoin’s performance to take a more calamitous turn.
At press time, while Bitcoin had recovered to climb north of $50,000, some key on-chain metrics seemed to suggest that selling pressure might not be done yet, especially on the miners’ side.
Bitcoin Miners’ Outflow Multiple, Volumes on the rise
According to Glassnode data, Bitcoin Miner Outflow Multiple climbed to touch a monthly high after BTC’s decline on the charts. The aforementioned metric relates to the period of time when the amount of Bitcoin flowing out of miners’ addresses is higher than the historical average.
Alongside the same, Outflow volumes of Bitcoin miners also climbed to a 1-month high with over $4.5 million on a 7-day average.
Now, while at first glance that may sound concerning over the short-term, the fact of the matter is that the long-term perspective is still in the green.
The Miners’ Position Index is a good example. When the market was correcting back in mid-January, the MPI had surged to a high of 12.65, underlining extremely high selling pressure from miners (An Index reading of over 2 suggests that a majority of miners are selling). On the contrary, the latest drop in Bitcoin’s price pushed the MPI only up to 3.50, with the same down to 2.56, at press time.
Further, additional data seemed to suggest that small miner outflows may have contributed to high outflow volumes since these entities need to balance out their cash reserves on a consistent basis.
Bitcoin hashrate and difficulty is still relatively high
The relative hashrate for Bitcoin has dropped over the course of February, but it is important to note that over the past 3 days, the relative change is very negligible. In fact, the current hashrate is still well above 2020’s highest rate, a finding that means that miners are still active and possibly profitable, despite corrections being the norm for most of the past 24-36 hours.
On the question of mining difficulty, the attached chart seemed to suggest that the difficulty was at an all-time high on 23 February with a hashrate of 21.724t. With a difficulty adjustment imminent on the charts, a minor correction would mean that bear-led corrections would not be dragged forward due to miners’ activity.
That being said, it remains critical to monitor miners’ position over the next couple of weeks.
Sign Up For Our Newsletter
Ankr adds Eth2 futures (fETH) to its staking system
Are Bitcoin’s long-term hodlers entering the seller’s market?
Elon Musk Explains to Peter Schiff What Money Is
Litecoin, Cosmos, Tezos Price Analysis: 21 February
Ripple now registered as a Wyoming business
Former BoE, BoC Governor Mark Carney joins Stripe board of directors
A Review of BTCGOSU — Reviewer of Crypto Casinos
Kraken Daily Market Report for February 21 2021
DeFi Protocol Primitive Finance Self Hacks to Prevent Exploit
Peter Schiff Now Discusses Bitcoin More Often Than His Beloved Gold
Is Ethereum heading to another ATH?
The Many Theories Of Elon Musk Being Satoshi Nakamoto
NFT Platform Ethernity to Launch IDO on Polkastarter
Long Blockchain Corp has officially been delisted by SEC
3 key factors that propelled Ethereum to $2,000 for the first time ever
Banks will be required to work with crypto, e-money and CBDCs to survive
Bitcoin Payments Make 20% of the Revenue of a UK Private Jet Company
Today 11:40 am EST: First Bitcoin Elite NFT Art Drop
MoneyGram suspends Ripple partnership, citing SEC lawsuit
Kraken Daily Market Report for February 20 2021
Blockchain1 week ago
Thai SEC schedules hearings to address crypto investor qualifications
Blockchain7 days ago
Motley Fool adding $5M in Bitcoin to its ‘10X portfolio’ — Has a $500K price target
Blockchain2 days ago
Ankr adds Eth2 futures (fETH) to its staking system
Blockchain6 days ago
The Graph adds support for Polkadot, NEAR, Solana and Celo
Blockchain1 week ago
International payment giant Visa considers adding crypto to its network.
Blockchain7 days ago
Blockchain1 week ago
Ripple’s XRP Has Shown A Great Deal Of Resilience In The Midst Of Legal Troubles
Blockchain1 week ago
Nigerians bounce back with a defiant response to the government’s Bitcoin ban