Two Words Every Bitcoin Trader Needs To Learn Right Now



Today i learned that Citigroup one of the big four banks that hold 39 percent of all U.S. customer deposits created what is known as a dollar or digital asset receipt a security similar to an ADR or American Depository Receipt

{ oh boi this is gonna be a long post sitback relax grab a coffee and enjoy :) }

Which allows interested parties to invest in cryptocurrency without actually owning the underlying asset. Does that sound familiar. Yeah that's strikingly reminiscent of the Vanak solid IGCSE physically backed bitcoin ETF currently under review by the S.E.C. due for a delay or decision by September 30th. Now this is important because the dollar will provide Wall Street with a yet another way to invest in crypto currencies.

Under current regulatory structures which will be less risky than holding the underlying assets themselves would this new receipt. We may see more asset managers and funds allocating capital towards cryptocurrency investments. Now some may say that with Coinbase and Bakht offering Custodial Services NASDAQ looking to trade crypto on their exchange and all the other Wall Street developments we've seen over the past year in addition to today's Citigroup revelation that the ETF is more or less irrelevant. What I'm trying to say is it's more important to discuss Wall Street's goal to financial lives bitcoin and essentially create more than the 21 million that can never exist. And that brings us to today's video topic rehypothecation and comingling. Soon they will roll off the tongues as freely as the term fiat currency does today thanks to the entry of Wall Street incumbents into bitcoin because rehypothecation and comingling are pervasive Wall Street practices that enable the financial system to create more claims to an underlying asset.

Then there are underlying assets. This can offset bitcoins algorithmically enforce scarcity and all else equal suppressants price. So let's get into what these terms actually mean for us and how they'll affect us moving forward so let's set the stage by providing some context prior to the financial crisis of 2008 credit risk was widely distributed across banks in the financial system during the financial crisis many banks went bust or needed bailouts after the financial crisis. The regulatory response was to centralise credit risk to concentrate it in the core of the financial system where most of it is today. Policymakers thought that risk could be better monitored and managed if it were centralised into a small number of institutions that regulators could watch more closely. In other words too big to fail didn't go away. It just changed geography. It now resides in the core of the financial system in its exchanges and its clearing houses and central derivatives counter parties. The centralised institutions and their various forms now stand in the middle of client trades and assume the counterparty risk that banks used to take for each other bilaterally because they are at the core of the system.

These financial institutions are literally too big to fail. In short much of the financial systems credit risk is now located in these financial institutions. One such institution is ice the parent company of The New York Stock Exchange and the soon to launch crypto trading platform backed. In other words the same institution that manages the risk of the financial system will now manage a large part of the Bitcoin market. So let's dive into the first of these keywords. We need to know about comingling. Comingling means that the financial institution or custodian will hold collateral. In this case. Bitcoins. In a comingled or omnibus account rather than segregating them for each client in their own wallets. Comingling reduces the probability of the custodian going bust but increases the severity of the losses. If it ever does what comingling means for us is that today's obligations can be settled with collateral received yesterday. So it reduces the probability of a shortfall. Today. It also means that for various types of collateral that bitcoins cash US Treasury securities etc. institutions can substitute them for each other because counterparty is only post the net of all their balances not the gross amount on each trade.

Now comingling an omnibus account means counter parties will have no transparency into where collateral that pledge ends up and no way to audit whether institutions liabilities exceed the amount of assets in the omnibus account and such credit risk could easily build inside the financial institutions without the ability to detect them. That's your second word. Rehypothecation. Rehypothecation means that multiple parties reported on their financial statements that they own the same asset. It is the process by which a lender receives an asset as collateral for a loan. This part is known as hypothecation and then pledges that collateral to cover its own exposure to a separate party at which point this is called rehypothecation and then that separate third party then pledges that same collateral to a different party and so on and so forth. The length of collateral chains can be several parties long and there's no means by which to track the length of that in real time. Meaning there is no means by which to determine how many for actually reserved assets have been created within the financial system. Now rehypothecation is very similar to fractional reserve banking which is a banking system in which only a fraction of bank deposits are backed by actual cash on hand and are available for withdrawals. Banks are required to keep a certain amount of the cash depositors give them on hand. That is if someone deposits a 100 dollars.

Banks can't lend out the entire amount. That said it isn't required to keep the entire amount either. Most banks are required to keep 10 percent of their deposit referred to as reserves. The only difference between fractional reserve banking and hypothecation is that banks use customers loans to create new money. Each time it is returned to the bank in the form of deposits. So in a way if a bank follows the rules they are lending practice with fractionalized reserve as much safer than hypothecation because if their loans get into trouble there is always a lender of last resort or the central bank to fall back onto. This is because the central bank will always function as a saviour to commercial banks whenever they're in trouble and they need the bailout. So rehypothecation is insidious and subtle. Individual financial institutions may appear solvent as they hold an asset against their debt but at a systemic level there is no way to back out of the double or triple or quadruple or quintuple counting of that same asset to understand how solvent the financial system is in aggregate. Or whether an individual institution is in fact solvent at all. If double counting were backed out CFTC chairman Christopher Giancarlo affectionately known as Krypto died after his positive comments on Krypto during a February 20 18 Senate hearing has been warning about this for years.

2016 speech Giancarlo detailed the practical impossibility of a single national regulator collecting sufficient quality data to recreate a real time ledger of the highly complex global swaps trading before Alios of all market participants he continued. At the heart of the financial crisis perhaps the most critical element was the lack of visibility into the counterparty credit exposure of one major financial institution to another.

Probably the most glaring omission that needed to be addressed was the lack of visibility. And here we are in 2016 and we still have it. And I think that's where we are right now too. The takeaway from all of this is how rehypothecation and comingling are antithetical to how bitcoin works or at least how it's supposed to work distributed ledger technology is a peer to peer value transfer framework that provides Byzantine fault tolerance with distributed databases updated with a consensus mechanism by its very design. It's meant to eliminate counterparty risk. And the limited supply of a digital asset is really special for there to ever only be 21 million bitcoins. If Bitcoin makes it to 20 140 for bitcoin to have copyright protection for something digital have permanence that is something very unique and yet using rehypothecation and comingling they can essentially create more than 21 million. So what are the implications of that. Is this really bad. Well for one rehypothecation and comingling are major components of how financial institutions make their money. If they did neither they would need to charge clients a lot more for the risk they assume.

Plus there are fat profit margins in rehypothecation collateral especially for types of assets that are hard to borrow or trade special. Bitcoin is the epitome of hard to borrow owing to its natural scarcity and because so many of the existing 17 million bitcoins are locked away in cold storage. So it's clear why these institutions want. But there's more

The centralization of risk in the financial system is not just in financial institutions. Asset custodians also centralize risk and they to commingle and re hypothecate owing to the custody rule. Most institutional investors use third party asset custodians and summary regulations for as many institutional investors to store assets centrally and trade with Central counterparts. They really can't trade peer to peer in the same way individual Bitcoin owners can and all but hedge funds and the very largest state pension funds probably can't sell costed either bitcoins. There are many issues for the CFTC and fed to consider when regarding Wall Street's rehypothecation and comingling of bitcoins preventing the problem in theory is easy. But preventing them would require massive changes to how Wall Street does business. And that's almost certainly wishful thinking. That's why comingling and rehypothecation are definitely coming to bitcoin. So what do you think. Are you upset that this will be the case. After all many in the community consider the phrase if you don't own your private keys you don't own your bitcoin to be law. On the flip side if this is how institutional investors will have to enter the space. Perhaps still creating a more stable market they'll indicate maturity.

And that's it for this post. Thank you so much for reading. And please consider following,upvote,resteem,comments etc good stuff

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