What You Should Know About StableCoins?

https://medium.com/coinmonks/what-you-should-know-about-stablecoins-cf2a00ac610b?source=rss----721b17443fd5---4

A coin with reduced volatility called stable coin which is suitable to use for daily use but still there are many things you don’t know about stable coins.

Techfrry

After bitcoin, so many cryptocurrencies launched and if you check coinmarketcap, you can find thousands of cryptocurrencies listed there. Majority of coins are highly volatile, which makes them suitable to investment but for everyday use stable coins come into work.

In this article we will read some important things about stablecoins and learn its impact on economy.

If you compare stable coins with other coins then if other coins are roller coaster then stable coins are the toy train.

Some stablecoins created by collateralized which means fiat back the stablecoin so when some stable coin comes into circulation then same amount of fiat get deposited somewhere in the bank.

Stablecoins are nothing but the digital fiat created over blockchain technology so let’s dive deep about stablecoins {Reference}.

in 1996, E-gold was launched by Gold & Silver Reserve Inc. where users account denominated by grams of golds so can one user able to transfer value to other users easily but after some time it stopped working because of legal issue {Reference}.

In 2006, again, a stable coin service started with the name Liberty Reserve in Costa Rica. Where users can create an account and transfer money with only a name, email address, and date of birth. Liberty Reserve USD and Liberty Reserve euro were pegged to the US Dollar and Euro, respectively, but in the money laundering case the company was shut down in 2013 by the US Government{Reference}.

We have no data that how many stablecoins launched and shutdowned in the past, but today’s stable coins are in much better position.

1. Everyday purchases and payments

2. Cross-border transfers

3.Stable trading asset

Stablecoins provide you flexible entry and exit to crypto market without converting your crypto into fiat which can charge high fees.

4.Protection from fiat inflation

Brutal inflation in Venezuela. Graph courtesy of Statista/IMF

1. Asset-Collateralized Stablecoins

Basically, Asset-Collateralized Stablecoins backed by three types of assets: 1. Fiat currency, 2. Commodities, 3. cryptocurrency, so let’s learn more about them.

  1. Fiat-Collateralized Stablecoins

Each amount of fiat collateralized new stable coins printed, which means if $1millions of stablecoin is in the circulation then there should $1millions of fiat reserved somewhere and when you cash out your stablecoins, then the amount you cash out get paid from the reserve and the stablecoins get destroyed.

Tether is the top stablecoin with rank three in coinmarketcap by market capitalization but Bitfinex, the company behind Tether, revealed last year that only 74% of all Tether backed by cash and securities. This is the point of concerns with fiat-backed stablecoins — I.e. trust in a central entity {Reference}.

The most advantages of using fiat-backed stablecoins are it is very simple to understand and to use because people are very familiar with fiat systems but the most disadvantages of fiat-backed stablecoins because these are created on the top of centralized system which means single point of failure, trust issue comes into place because you don’t know they are properly reserving fiat or not, Regulatory oversight, and Inefficiency.

2. Commodity-Collateralized Stablecoins

commodity-collateralized stablecoins backed by commodities like gold, real estate, and oil.

It gives you access to buy commodities in a fraction because, in reality, you can’t buy gold or oil in fractions and you need not think about the security of your stored gold because it is in the digitalized form so you can store them in cold storage for long period and commodities backed stablecoins are stronger to fight inflation than fiat-backed stablecoin.

But the disadvantages of commodities backed stablecoins are similar to fiat-backed stablecoin {Reference}.

3. Crypto-Collateralized Stablecoins

The concept of crypto-collateralized stablecoins is more interesting because it gives you permissionless decentralized ecosystem because these stablecoins are backed by cryptocurrency.

Everything built on the blockchain so no trust issue comes into place, and you will never face the disadvantages you face in fiat- and commodity-backed stablecoins. but cryptocurrency prices can be volatile and to absorb these price fluctuations and mitigate risk you may face over collateralize problem, which means you may force to deposit $150 of crypto to get $100 stablecoins {Reference}.

4. Non-Collateralized Stablecoins

This is the stablecoins don’t use any collateral to back them and the concept of non-collateralized stablecoins are inspired from fiat system because you know fiat currencies are not backed by any tangible assets but by faith of the people.

The primary category of non-collateralized stablecoins is algorithmic stablecoins. Also known as the “Seigniorage Supply” model where its algorithms and smart contracts to balance supply and demand means when demand of the coin increase more coins generate and when demand decrease it buy these coins in circulation.

The above model failed and algorithmic stablecoins include Nubits, BitBay, and others, most of which either haven’t gained traction or shut down.

Now Meter is creating a stable coin which is called “economic consenus-based” stablecoin which uses the profit-seeking behavior of Proof-of-Work miners instead — and is immune to many of the drawbacks of algorithmic stablecoins.

These are the most decentralized stablecoins of till now because most of the infrastructure created on the blockchain, they don’t need collateral but it also has some disadvantages is that algorithmic stablecoins rely on continual future demand in order to be successful{Reference}.

5. Hybrid Stablecoins

These kinds of stablecoins are a combination of multiple aforementioned models, which means it combines of fiat-collateralized, commodity-collateralized, crypto-collateralized, and algorithmic — into a single token.

These coins combine characteristics of over one coin which is can attract users and investors but may be complex to understand for some people and also be scrutinized by regulators if they involve any aspects that resemble securities {Reference}.

Also, Read

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Bitcoin & Tether and DeFi’s Next Growth Drivers

https://doseofdefi.substack.com/p/bitcoin-and-tether-and-defis-next

DeFi has grown considerably in 2020, to say the least. It’s been 3 months since the launch of COMP set off a never-ending stream of farms, forks, crashes and heists. The growth in the space has been hard to keep track of with new launches weekly, as is calculating market sizing with asset rehypothecation through the system.

Roughly speaking, the DeFi market has at least 6x’ed in the past 3 months with DeFi Pulse’s latest industry TVL at $9.1bn USD – up from $1.27bn the day before COMP launch.

While some of this increase is from asset appreciation, not all of the growth can be attributed to Twitter’s speculative echo chamber. New assets and investors have poured into the space, increasing usage of DeFi platforms and the amount of collateral and liquidity supplied.

At the beginning of the year, I said that Bitcoin and Tether were the two most important assets to DeFi growth in 2020. Yield farming has been the catalyst, but BTC and USDT inflows have been the largest source of fresh capital.

Tether has long dominated the centralized world but had little presence in DeFi, where Dai and USDC proliferated, but in the last three months, USDT usage in DeFi has exploded with almost $900m locked up on-chain. Tether’s DeFi journey was jumpstarted by Compound, hundreds of millions of USDT flowed into Compound after it approved USDT borrowing and made Tether the crop of choice to farm COMP.

Tether moved on from Compound but stayed in DeFi and now has a larger presence than Dai and competing with USDC.

The DeFi inflows were from Tether’s base in Asia and its prevalence amongst traders – both segments hopped on the yield farming hayride in full force over the summer. With the further gamification of DeFi, Tether could see increased usage in the degenerate gambling space, if sUSD doesn’t beat it there.

In addition to Tether, Bitcoin synthetics have been the other asset with strong organic inflows into DeFi. It remains most useful as another source of collateral, and Bitcoiners are perhaps the most hospitable market because so many are already using it as collateral to take out loans in the centralized world.

The Bitcoin on Ethereum market has also exploded, growing from $45m in mid-June to almost $1bn in synthetic BTC today. WBTC, a custodied BTC wrapper, is the largest with renBTC providing the first non-KYC’d bridge for Bitcoin to Ethereum.

Amidst the summer’s farming craze, a consistent flow of Bitcoin has flowed onto Ethereum. About half of it is used as collateral for on-chain loans, while most of the rest is farming CRV. Synthetix’s sBTC and Huobi’s hBTC have tried to attract investors with attractive farming yields, but they have not gotten much liquidity outside of subsidized pools.

CREAM, a Compound fork, accepts renBTC as collateral but has only $3m in renBTC deposits. WBTC is far ahead on the BTC as collateral in DeFi – largely in Aave and Maker.

Altogether, almost $1.5bn of Tether and synthetic Bitcoin has flowed into DeFi over the last 3 months. Looking forward, Bitcoin and Tether still has room to grow in DeFi and should remain top targets for any DeFi product.

Investors: new players for DeFi games

Tether and Bitcoin powered the organic inflows that drove the farming craze and new value creation from token launches, but who was driving these flows? And who are the next group to fall under the DeFi spell

The DeFi Curious. Something clicked in May and June. Perhaps it was the quarantine, Balancer and Uniswap v2 launch, the efficiency of Curve, or the COMP distribution, but DeFi started appearing outside of core DeFi fanatics and creeped into adjacent crypto communities.

DeFi has an obvious appeal to the crypto trader crowd. Bitmex CEO Arthur Hayes loves $YFI but is also willing to jump on whatever new food coin emerges. Three Arrows Capital is a more buttoned-up outfit that has gone heavy into DeFi – and quite successfully. And of course, perhaps no one has gone more DeFi than FTX CEO and SushiSwap maestro Sam Bankman-Fried. Luckily for him, the DeFi label is self-applied.

The counterpart to the crypto trader is the crypto VC. VCs are not exactly new to DeFi, but activity has increased and their role has moved on-chain with the rise of fair launches. There is a growing rivalry between VCs and traders centered on DeFi – is it a consumer product with network effects or a complex financial instrument (why not both? Gauntlet CEO Tarun Chitra said it was “reminiscent of the previous talent ‘war’ between HFT and online ads”.

The Crypto Center. If the DeFi Curious hope to get in on a rocket ship taking off, the Crypto Center pride themselves on driving the crypto topic du jour. The most obvious place to start is Laura Shin’s Unchained Podcast. The last three podcasts have been DeFi-focused, featuring Yearn.Finance’s Andre Cronje, Polychain’s Olaf Carlson-Wee and a joint appearance with Dragonfly’s Haseeb Qureshi and Paradigm’s Dan Robinson.

Epicenter, a more technical podcast, has featured a DeFi-heavy lineup throughout 2020, including episdodes on Aave, Opyn, Nexus Mutual, UMA, Balancer and Loopring.

And of course, no one represents the Crypto Center like Mike Dudas, founder of the Block. Dudas has gone full DeFi degen, months after begrudgingly allocating some of his precious BTC into ETH. Just this weekend, he tweeted, “DeFi is the most interest thing happening in cryptocurrency and digital assets today”. The link is presumably broken since Dudas auto-deletes his tweets.

Who’s Next?

To be clear, there is still ample room for DeFi growth from these existing crypto communities – just as Bitcoin and Tether remain attractive targets for DeFi projects, but the question is who catches the DeFi bug next and what will they bring? A couple groups:

  • Fintech – Dudas also has a foot in what could be an adjacent source of talent, capital and compliance. The decade life cycle of fintech is coming to an end with big exits and companies with large user-bases. Some of the venture funding chasing fintech could shift over to DeFi, but the bigger opportunity is DeFi integrations with existing, popular consumer products. Robinhood and the Cash App allow easy BTC & ETH purchases, but one of the large fintech’s could integrate Compound or allow easy Uniswap/Balancer liquidity provisioning.

  • Wall Street – Wall Street is slowly embracing an institutional approach to Bitcoin, and presumably ETH is next, but traditional financial institutions seem far away from building and using blockchain-based financial products and services, outside of hodling. Still, Wall St traders could become a strong source of flow from their personal capital and institutions will make venture and equity investments. The one area to watch is the on-chain derivative space. There is a lot of interest and experimentation now, but it could benefit from outside expertise (or directed investor flow)

  • Gaming (and sports) – Perhaps this distinction is moot now because so much of DeFi has been gamified (is this a financial product?) but DeFi protocols could find inflows from a larger, entertainment-first mainstream audience. Sports are the most popular way to gamble; maybe prediction markets can see this flow. Perhaps growth from such a market is dependent on layer 2 scaling and lower transaction costs.

  • Geographies – DeFi’s promise is a digitally native, globally accessible financial system, but adoption is likely to occur country by country. Tether, of course, is primarily an Asian phenomenon, as is all of the DeFi Curious (Arthur Hayes, Sam Bankman-Fried, Three Arrows Capital). Country-level restrictions could drive larger flows into DeFi, or alternatively, a central bank digital currency could create an easy on-ramp into the DeFi world. Given the infrastructure already in place, any project with a local banking relationship and fiat on-ramp, could reach scale through the retail market. No-loss lottery PoolTogether’s largest market is reportedly Indonesia.

Chart of the Week: DAI > MKR

Beautiful, if depressing chart from Makerburn.com. Dai supply has shot up over the last few months, almost entirely due to the yield farming craze, where Dai is crop of choice – on Compound at least – because it has the least overhang over borrows. Maker has onboarded new collateral types and raised debt ceilings to deal with the strong Dai demand. Unfortunately, MKR has not been able to participate in that growth. With fees at 0 since March, no MKR has been burned, despite the fact that MKR’s risk profile goes up with the supply of Dai, since it’s the ultimate backstop in the event of default. Dai demand remains strong as does its integration into DeFi, but the larger concern is teams building now for USDC and Tether, eroding Dai’s “DeFi’s default stablecoin” status. With another price rise in Dai over the last week, there is currently an on-chain poll for a “Quantitative Easing” initiative, while there is a renewed push to onboard real world assets as collateral. In a Maker forum poll, 56% estimated 200-500m more Dai will need to be printed to meet current demand; 21% said 700m-1bn.

Tweet of the Week:

Perpetual Protocol launched PERP last week using a Balancer Liquidity Bootsrapping Pool (LBP), becoming the first to use the token distribution method. LBPs automatically adjust the weight between a new token and a listing token, in this case PERP and USDC. At launch, the weight is set at 90/10 PERP/USDC, creating a very high price and then automatically adjusts the weight down to deter front-running and whales. Parsec Finance founder Will Sheehan approves, arguing that it creates a smoother price discovery. Market cap does seem a bit high still ($255m), and it appears to have raised $8.5m? Curious as to why USDC and not USDT as Perpetual Protocol is backed by top trading firms (2/3 of DeFi Curious).

Odds and Ends

  • DeFi Pulse and Set team up to launch DeFi Pulse Index (DPI) Link

  • Hacker drains $8.5m out of BZX again (and returns it?) Link

  • Gitcoin Matching Grants Round 7 is live Link

  • YAM replanting and launch Link

  • Grand opening of SushiSwap Link

  • Hegic Launches Initial Bonding Curve Offering Link

Thoughts and Prognostications

That’s it! Feedback appreciated. Just hit reply. Written in Brooklyn, where I’m kind of excited for fall. Long-ish post to distract from the daily farms. May switch to Tuesday delivery :-/

Dose of DeFi is written by Chris Powers. Opinions expressed are my own. I spend most of my time contributing to DXdao. All content is for informational purposes and is not intended as investment advice.

Congressman argues for permissionless digital dollar to demonstrate U.S. values

https://www.ledgerinsights.com/digital-dollar-congress-permissionless/

Today, Congress held an online hearing on how to distribute COVID-19 stimulus payments better, as part of the U.S. House Committee on Financial Services. Congressman Tom Emmer acknowledged that really there were two topics: firstly, how the government can better use technology to deliver services and secondly a central bank digital currency (CBDC). The focus […]

The post Congressman argues for permissionless digital dollar to demonstrate U.S. values appeared first on Ledger Insights – enterprise blockchain.

Why Tether has printed $5 billion USDT this year

Tether and Bitfinex CTO Paolo Ardoino today revealed why Tether has minted $5 billion in the last six months, more than at any point in the company’s history. After slowly climbing the market cap rankings, Tether has now risen above XRP to reach third place in the crypto rankings, with a market cap of $9 billion. But what’s behind this massive surge in demand?

Speaking on the “On The Brink With Castle Island” podcast, Ardonio said demand has been driven by exchanges craving cash, especially after the market crashed in mid-March.

Tether critics claim the stablecoin coin is used to inflate Bitcoin price. New research from UC Berkley professors suggests that isn't the case.
Tether’s market cap is now greater than $9 billion. Image: Shutterstock.

“On 12 and 13 of March, when there was that huge drop—50 percent in Bitcoin and other major currencies—we have seen people being stuck on fiat on-ramp exchanges because they couldn’t move fast enough their dollars in order to exploit the market conditions or protect themselves,” he explained.

He suggested that the inflow of money wasn’t coming from outside the cryptocurrency sector but from exchanges who wanted more Tether.

Why Tether is the real king of crypto

“I believe that Tether is absorbing part of the cash wealth that is sitting in cash in bank accounts on many other exchanges,” he said, adding, “We have seen OTC desks that have started dealing massively in Tether as well.”

Ardoino also spoke about the exchange’s inflows and outflows, its banking situation and whether Tether can grow to $200 billion.

For context, crypto exchange Bitfinex and stablecoin issuer Tether are two separate companies, run by the same people. Tether is responsible for issuing the Tether (USDT) stablecoin, which now has a market cap of $9 billion. Each dollar stablecoin is purportedly backed up by Tether’s reserves, although the company has never produced an audit to guarantee this.

Bitcoin flowing out of Bitfinex

In the interview, Ardoino was asked why large amounts of Bitcoin (BTC) had been flowing out of the Bitfinex exchange, while big amounts of Ethereum (ETH) flooded back in—a phenomenon that had many market commentators scratching their heads.

Ardoino explained that several large over-the-counter purchases were the reason for the sudden liquidity in its Bitcoin holdings.

He also noted that for months, if not years, the Bitcoin price on Bitfinex had been higher than on other exchanges, but that this has reversed since March 12 (when there was a large crash in the price of Bitcoin and traditional currencies). He suggested this lead to more arbitrage opportunities, where traders buy Bitcoin for a lower price on Bitfinex and sell on other exchanges for a profit.

“On the Ethereum side, we have seen a really considerable inflow, more than $1 million Ethereum in the last two or three months,” Ardoino said before suggesting it could be in preparation for Ethereum 2.0.

The road to $100 billion

Ardonio was also asked about Tether’s scalability, and how it would work with banks if the project’s market cap kept growing.

“It’s theoretically not complicated to go from $0 to $200, $300 billion but if you surpass $100 billion and more, it becomes more complex to deal with banks,” said Ardoino.

Tether has had difficulties in the past with its banking partners. It lost $750 million of its reserves when accounts in a Panamanian bank were seized by law enforcement. To solve this, it created a cryptocurrency designed to work as a loan from the crypto community to cover these losses, which it intends to pay back. It has also stopped paying dividends to its shareholders.

A look at Crypto Capital, the company serving both Bitfinex and QuadrigaCX

“I believe that if we have to go to $100 billion then it would require probably a tier one bank to help us in the enterprise. The more you grow, the more you need diversification, and the more you need to step up the game and deal with the much bigger banks each time,” he said. But there are clouds gathering in the global economy that could scupper Tether’s expansion plans.

The specter of negative interest rates—where banks charge depositors to hold their money—has been mooted by several central banks recently. If implemented, Tether would have to pay banks holding its cash reserves. “It would be possible to still break even in that situation. To still maintain the capital and super safe investments. I think that it is harder if you have $100 billion, but if you have $9 billion it’s definitely something that is achievable,” he said.

Perhaps there is a limit to Tether’s rapid growth after all.

Federal Reserve Bank Report on CBDCs: Central Banks May Become Deposit Monopolist, Sorry Commercial Banks

https://www.crowdfundinsider.com/2020/06/162436-federal-reserve-bank-report-on-cbdcs-central-banks-may-become-deposit-monopolist-sorry-commercial-banks/
The US Federal Reserve Bank of Philadelphia has published a paper on Central Bank Digital Currencies or CBDCs. This is a hot sector of digital assets as CBDCs have the potential to supplant paper currency at some point in the future. Yet many questions remain regarding the systemic impact

Central Bank Digital Currencies (CBDCs): A Crisis Recovery Tool For Governments

https://www.forbes.com/sites/pawelkuskowski/2020/06/07/central-bank-digital-currencies-cbdc-a-crisis-recovery-tool-for-governments/
Central Bank Digital Currencies (CBDCs) could give central banks and governments more options in their economic recovery efforts. CBDCs provide a mechanism to help ensure the continuity and sustainability of economies, along with increasing both speed and transparency of payments.

Central banks’ monetary policy as a means for economic control

https://medium.com/coinmonks/central-banks-monetary-policy-as-a-means-for-economic-control-593e64190172?source=rss----721b17443fd5---4

Central banks’ Monetary Policy as a Means for Economic Control

Credit creation and money printing, the total takeover of the free market by central banks, and how Bitcoin solves this?

Recently, more and more people and academics voice their criticism of the central banking system. The criticism is focused on the fact that central banks and banks create money out of thin air in the process of credit creation and asset purchase as discussed in my previous article.

This article lays out my findings focusing first on the central bank’s ability to influence the economy by setting interest rates. In this process, commercial banks act as intermediaries having their own incentives. Then, and even more importantly, the impact of central banks’ asset purchasing programs on the economy is discussed which are better known under the term “quantitative easing”.

Finally, the decentralized alternative to central banking “Bitcoin” is highlighted as an antithesis to the current banking system.

This article is covered at the Value of Bitcoin conference and soon available as video on YouTube

Detail of the U.S. one dollar bill

“The ultimate constraint on money creation is monetary policy. By influencing the level of interest rates in the economy, the Bank of England’s monetary policy affects how much households and companies want to borrow. This occurs both directly, through influencing the loan rates charged by banks, but also indirectly through the overall effect of monetary policy on economic activity.” Bank of England, Quarterly Bulletin, 2014 Q1

The Central Bank, Economy and Interest Rates

Central banks exercise indirect control on the economy by artificially low-interest rates. This allows banks to easily refinance themselves to eventually give out debt. So, central banks influence how much credit is created by setting the interest rate. Artificially low-interest rates lead to great distortions in the economy namely boom and bust cycles and misallocation of resources.

Central bank’s control on the economy through interest rates is indirect because the amount of debt created eventually depends on the demand for debt. An article by the Bank of England explains this concept very well from which I took the following excerpt:

“Banks first decide how much to lend depending on the profitable lending opportunities available to them — which will, crucially, depend on the interest rate set by the Bank of England. It is these lending decisions that determine how many bank deposits are created by the banking system. The amount of bank deposits, in turn, influences how much central bank money banks want to hold in reserve (to meet withdrawals by the public, make payments to other banks, or meet regulatory liquidity requirements), which is then, in normal times, supplied on demand by the Bank of England.”

To adequately understand the extent to which central banks influence the amount of credit created by banks, it is crucial to understand the model of banks.

The Business model of Banks

As any company, a bank intends to maximize its profit by minimizing costs and maximizing revenue. A bank generates revenue from the interest payments of the debt they issued to its debtors. Banks can increase their revenue by either increasing the interest rate or by increasing the amount of debt loaned.

Banks are competing among each other in attracting debtors which is why a bank would lose potential debtors by arbitrarily increasing the interest rate on debt. So this opportunity is limited due to the competitive environment. As a result, banks have an incentive to create as much debt as possible to increase their revenue through the related interest payments.

A bank intends to maximize its profits

The costs of banking are comprised of the bank’s operational costs, the interest on their customers’ savings account (before they were set to zero), and the interest they need to pay for receiving a credit from the central bank.

This central bank money is crucial for a bank’s operation namely transferring their customer’s funds from one bank to another. This aspect will be highlighted in the next sections. Before that, the bank’s ability to create money out of thin air through credit creation is briefly recapped as discussed in length in my previous article.

Banks create money in the process of credit creation

In the process of credit creation, banks note the amount of the loan on the asset side of the bank’s balance sheet and insert this money in the bank account of the debtor which is found on the liability side of the bank’s balance sheet.

Therefore, the credit sum is added to both sides of the balance sheet: the “claims on customers” on the asset side (the debt) and the “claims by customers” on the liability side of the bank (the loaned money).

When debt is repaid, then the bank’s claims in relation to this debt is reduced. This reduction in claims is noted on the asset side of the balance sheet. In this process, the money that was generated through credit creation is destroyed.

The bank does not generate revenue directly with the debt repayment but rather with the interest rate on the debt which is the main revenue stream of banks. However, the debt repayments are related to the reserves a bank holds at the central bank. If the debt is not paid back, then the value of the claim must be corrected downwards which reduces profits and therewith equity. The relation between reserves and customer transactions is discussed in the following.

The necessity of reserves to enable transactions of customers

“A bank’s business model relies on receiving a higher interest rate on the loans (or other assets) than the rate it pays out on its deposits (or other liabilities). Interest rates on both banks’ assets and liabilities depend on the policy rate set by the Bank of England, which acts as the ultimate constraint on money creation.” Bank of England, Quarterly Bulletin, 2014 Q1

Let’s dig deeper to understand when banks issue credit. First, banks assess the creditworthiness of the debtor (credit risk) which is then priced into the interest rate the debtor receives. The bank will only lend out money if the business is assessed as profitable.

This depends on the return of the investment which we consider to be constant for simplicity. Besides that, the most important factor is the interest rate at which the bank can refinance itself from the central bank. The rate at which banks can refinance themselves at central banks is essential because banks require central bank money for settlement between banks.

This “central bank money” is called “reserves”. The reserves are the money that a bank holds at the central bank. This relates very much to the concept of a consumer depositing money at a bank. Just as the consumer holds money in the bank account of the bank, the bank holds money in the bank account of the central bank.

Reserves are the facilitator of interbank transactions. Reserves are in particular relevant when a bank’s customer transfers money to someone having a bank account at another bank. A lack of reserves would pose a threat to the bank’s ability to process transactions (liquidity risk). This concept is illustrated in the figure below.

The figure shows what happens on the bank’s balance sheets when a customer transfers money from his account to another account at a different bank. In the example above, money is transferred from “Citibank” to “Star Bank”. As expected, Citibank loses deposits of its customer on the liability side. But Citibank also loses reserves it holds at the central bank. This is because Citibank has to transfer the same amount of reserves to Star Bank as the customer transfers funds. This has vast implications for banks on their demand for reserves. Also, this is why banks lend money among each other to balance the shifts of customer’s funds.

We have discussed two important concepts:

  1. The revenue stream of banks (primarily interest payment on debt)
  2. How banks create money in the process of credit creation
  3. The necessity of reserves to enable transactions of customers

Now, these three aspects are brought together.

A bank needs reserves — which is central bank money — to fulfill transactions by its customers. This limits a bank’s ability to create debt. A bank will only create as much debt until it does not run out of reserves which would impair its ability to process transactions of its customers. This is the case because the generated debt is placed in the entry “deposits by the people” as discussed in the recap of my previous article. This deposit can subsequently be transferred to another bank through normal business transactions. Then, the bank needs to transfer reserves as well. So the bank has a demand for reserves to process transactions. The demand for reserves increases with new debt since the bank must withhold reserves to process the debtor’s business transactions. This is why banks are obliged to hold a percentage of their liabilities (customer deposit) as a reserve at the central bank called “reserve requirement”.

A bank will give out as much debt as possible to increase its revenue through interest payments on this debt. At the same time, the bank needs reserves to process transactions. These reserves come at a cost. The bank will only give out credit if the costs of reserves are lower than the revenue from the debt. If the costs of reserves are reduced, more of the possible businesses through debt creation become profitable, i.e. more debt will be lent out.

We have discussed the importance of the refinancing rate on banks’ decision to give out additional debt. In order to understand the macroeconomic implications of the refinancing rate in more detail, the mechanisms of banks competing among each other must be understood.

Competition between banks

“In order to make extra loans, an individual bank will typically have to lower its loan rates relative to its competitors to induce households and companies to borrow more. And once it has made the loan it may well ‘lose’ the deposits it has created to those competing banks. Both of these factors affect the profitability of making a loan for an individual bank and influence how much borrowing takes place. “ Bank of England, Quarterly Bulletin, 2014 Q1

Banks are in competition with each other. Banks compete for two things: the interest on loans and the reserves that come with deposits. To attract more debtors, banks can lower their interest rate on debt relative to other banks. At the same time, banks need to make sure that they can serve transactions for which they require reserves. They receive reserves either through borrowing at the central bank or by attracting deposits. New deposits that originate from another bank come with reserves as explained in the former chapter. To attract more deposits, a bank can increase the rate they offer on bank deposits. The Bank of England states “By attracting new deposits, the bank can increase its lending without running down its reserves”. The bank thereby needs to evaluate whether it is more reasonable to attract new deposits through appealing interest rates or to borrow reserves directly. In the past, the former was more reasonable for banks, however, this has shifted recently.

Attracting new deposits is merely a redistribution of reserves that should not have macroeconomic implications. In contrast, lowering the refinancing rate allows banks to take on more debt from central banks which expands the number of reserves in circulation which then influences the economy on a macroeconomic level. We always need to look where new money is created for understanding the macroeconomic implications and this is precisely the case when new credit is created — both when central banks lend reserves to banks and when banks create new credit and give it to their customers. As a result, the competition for reserves by attracting deposits is negligible on a macroeconomic level.

As soon as the central bank lowers the refinancing rate, banks can borrow reserves at a cheaper rate. As a result, banks can expand their business by giving out more debt since they can refinance themselves at a cheaper rate to serve the subsequent transactions of debtors. Since banks are in a competitive environment, banks will reduce the interest rate on debt to attract more debtors. This is the mechanism through which a lowering of the refinancing rate leads to a lowering of the interest rate on commercial debt.

Reduced interest rates on debt attract new debtors demanding debt money. This in turn leads to an expansion of the debt money in circulation. Moreover, artificially low-interest rates make investments profitable that destroy capital. Investment opportunities that were not profitable have become profitable due to the reduction in capital costs. Such a distortion is never sustainable and the boom must eventually turn into a bust which is explained very well in the article “Bitcoin and The Business cycle” by Ben Kaufman.

In the following, you can find information on the banks refinancing rates at central banks. Data on the recent development of the Federal Reserve’s (Fed) overnight bank funding rate can be found here. The current overnight bank funding rate is at 0.05%. Information on the European Central Bank’s (ECB) marginal lending facility, which is the interest rate for banks to borrow money overnight and the rate on refinancing over one week through main refinancing operations can be found here and here. Both forms of funding require collateral in the form of securities. The current rate of the marginal lending facility is at 0.25% and the main refinancing operation is at 0%.

The central bank’s ability to directly influence the economy through asset purchases

“Once short-term interest rates reach the effective lower bound [which is 0.5%], it is not possible for the central bank to provide further stimulus to the economy by lowering the rate at which reserves are remunerated. One possible way of providing further monetary stimulus to the economy is through a programme of asset purchases (QE).” Bank of England, Quaterly Bulletin, 2014 Q1

Before delving deeper into the implications of quantitative easing (QE) on the economy, the concept of QE is explained. Quantitative easing essentially means that the central bank buys assets in large quantities from the market. In this process, banks act as intermediaries. The bank can either sell assets it already had in possession to the central bank or it buys assets on the market which the bank then sells to the central bank. But with which funds are these assets bought from the market? By creating them out of thin air which I explained in my previous article to which I make a quick recap here.

Central banks and the Market assets

Banks can simply create the money to buy assets as discussed in an article from the Bank of England. A bank does so by adding the value of the assets on the asset side of the balance sheet and by inserting the funds for the assets on the seller’s bank account.

The same principle holds when a central bank buys assets from a bank. The central bank adds the value of the asset on the asset side of the central bank’s balance sheet and inserts the funds in the bank’s bank account which is called “reserves”. As explained in chapter “The necessity of reserves to enable transactions of customers”, these reserves are the bank accounts which commercial banks hold at the central bank.

Note: A figure explaining this concept can be found in my previous article. Chapter “Note on whether fiat money is debt or money” shows differentiation between different money forms namely the money created at central banks (base money) and the money created by commercial banks (broad money).

Central banks and the Market distortion

We have seen how banks and central banks can buy assets infinitely through their monopoly of creating money out of thin air. We have also discussed that low-interest rates lead to malinvestments and therefore artificial boom cycles that eventually must go bust. Quantitative easing is a means to prevent the boom going into a bust by artificially inflating demand for junk assets which artificially pushes their price upwards. In a bust, the overvaluation of assets would normally correct, namely in the following process: Investors would sell their assets which results in a sell shock — the bubble bursts. But since the central bank buys junk assets on a grand scale, this sell pressure is countered. The bust is artificially prevented. The recent chart on the S&P 500 index shows this mechanism very well. The S&P 500 index showed the lowest value on March 23, 2020, which is the day when the Fed announced buying ETFs to “stabilize the market”.

Chart on the S&P 500 index taken from Trading View

If the financial world would be in alignment with the real world, a reduction in production — as during a lockdown — would reduce the cash flow of a company and therefore comes with a devaluation in its stock price. But the financial world does not reflect reality anymore due to incredible market manipulation by central banks through artificially lowering the interest rate and artificially altering demand through asset purchases on a grand scale.

This applies in particular to government bonds that are purchased in great quantity by the Fed during quantitative easing. This constant demand for government bonds induced by the central bank keeps interest rates on government bonds artificially low. This has great implications on the risk rating of all assets since the base risk rate is per definition equal to the interest rate of government bonds.

Central banks and the Bailouts

“QE involves a shift in the focus of monetary policy to the quantity of money: the central bank purchases a quantity of assets, financed by the creation of broad money and a corresponding increase in the amount of central bank reserves. The sellers of the assets will be left holding the newly created deposits in place of government bonds. They will be likely to be holding more money than they would like, relative to other assets that they wish to hold. They will therefore want to rebalance their portfolios, for example by using the new deposits to buy higher-yielding assets such as bonds and shares issued by companies — leading to the ‘hot potato’ effect discussed earlier. This will raise the value of those assets and lower the cost to companies of raising funds in these markets.” Bank of England, Quaterly Bulletin, 2014 Q1

The above quote explains very well how individual investors receive new liquidity through the quantitative easing program. Central banks buy the assets that investors discard on a large scale in order to “stabilize the market” meaning preventing the bust. Those assets that are sold on a large scale are in reality downgraded and considered as malinvestment by the selling investors. This means that central banks bail out investors on a large scale. QE allows investors to liquidate their junk assets at a high price which eventually allows them to reallocate their capital to more profitable investments. The bank serves as an intermediary in this process buying assets from individual investors and then selling them to the central bank.

The Economic takeover by Central banks

I first lay out the concept why a creditor receives power through giving out credit: Assume a bank lends out money to a middle-class person allowing him to buy a house. This debt is securitized with the house. Now, the bank who gave out the debt has rights towards the borrower, namely the right to receive the money-back which the banks created out of thin air in the first place. If the borrower cannot pay back the money, then the bank may dispossess the debtor and seize the house.

Central banks exercise direct control on the economy through the (selective) purchase of assets. This provides funding to the related parties issuing or selling these assets and transfers ownership to the Fed. This applies to all asset classes that are bought in the quantitative easing program such as government bonds, mortgage-backed securities, bonds, and stocks (or more precisely ETFs). In the last years, the ECB even engaged in subsidizing projects considered “green” through green bond purchase programs.

Through the ability to selectively purchase assets, central banks can bring structural change to the economy by influencing the financial system. The ECB declares very openly:

“The Eurosystem may carry out structural operations through the issuance of debt certificates, reverse transactions and outright transactions. These operations are executed whenever the ECB wishes to adjust the structural position of the Eurosystem vis-à-vis the financial sector (on a regular or non-regular basis).“

Note: Outright transactions are used to finance governments via government bonds bought on secondary markets. They were introduced to “saving the euro” under Draghi.

Reverse Transactions are operations whereby the central bank buys or sells assets under a repurchase agreement or conducts credit operations against collateral.

More details on the asset purchase program of the ECB can be found here. On this website, there is a section on “Corporate sector purchase programme” where you find a list which corporate securities were bought by the ECB (in the FAQ under “List of corporate bond securities held under the CSPP/PEPP”).

The Federal Reserve almost doubled their assets as seen in the recent movements in their balance sheet. During the lockdown, the FED created more than USD 2.800.000.000.000 (2.8 trillion). Recently, Neel Kashkari, a representative of the Fed announced that the Fed has no limitations in printing money. The majority of this money is used to buy government bonds. The government can distribute the money they received from these government bonds at free will and lobbyists are waiting in line. In the United States, big corporates stand in line asking for bailouts, among that airlines, hotels, cruise companies.

The power structure of money creation

We can conclude that the power structure of money creation is as follows: First in line are the central banks as lenders of last resort followed by banks who also have the right to create money out of thin air. Governments benefit the most from this system since they get the cheapest credit. This leads to an enormous concentration of power to these central authorities. This conflict of interest explains very well why governments have no incentive to outlaw such banking procedure although it may be considered “appropriation of someone else’s property or outright embezzlement or, more directly, counterfeiting”. (Rothbard, 1962, p. 809)

The reader may wonder why I consider the central bank as superior to governments in the hierarchy of control. I would like to refer to this statement in the “Joint Hearings Before the Subcommittees of the Committees on Banking and Currency of the Senate and of the House of Representatives, Charged with the Investigation of Rural Credits, Sixty-third Congress, Second Session. February 16, 1914.”

Let us control the money of a country and we care not who makes its laws” Mr Daniel said. I consider central banks superior to the government from a power perspective as long as the government does not outlaw such banking procedures. Since the government is financed by the central bank, it is dependent on the central bank. In theory, the government has the ability of the central bank as it was done in the past already. This possibility, however, becomes more and more difficult with increased dependence.

The above statement describes the implications of a debt system on the people as follows: “The people can never be free ‘as the borrower is the servant of the lender’”. Our monetary system is based on debt in two ways:

  1. Federal Reserve notes are backed by future tax payments which are debt of the government served through the tax payments of the people. Essentially, the taxpayer is the collateral for Federal Reserve notes.
  2. Increasing the money supply leads to inflation thereby pushing the people of the country more and more into debt to finance their living.

We conclude that central banks can exercise tremendous influence on the economy through dictating monetary policy. Their power is directly related to their ability to create money out of thin air.

Bitcoin is a freedom technology

Seeing the extent to which the central banking system is used as a means of control — or even massive takeover, one may develop or strengthen a negative relationship towards money. But money does not need to be this way. A monetary system may serve as a means of control or as a means to achieve freedom.

Bitcoin opened my eyes to this. Money and property rights allow people to be self-sovereign and independent of a beneficiary such as the government — a wolf in sheep’s clothing. Money is the engine that keeps an economy going facilitating trade, specialization, and prosperity.

Money can serve as a store of value for future investments to build in a sustainable way. These aspects of money were inverted through the fiat system. A system was created that distorts markets, bails out the most reckless, supports misallocation of resources, and leads to boom and bust cycles harming the economy and sustainable development of humankind on a grand scale. This anti-human monetary system is enabled through the government legalizing a banking procedure which essentially dispossesses the large majority of the people for the benefit of a small elite.

Bitcoin is a monetary revolution that brings a paradigm shift to all aspects of life. Bitcoin enables savings for future investments expanding the time preferences of an individual to more sustainable actions. Bitcoin enables financial sovereignty to preserve individual freedom.

Bitcoin makes us question: Do we need a government? Or do we want to make our own laws and create our own forms of collaboration as in free private cities? Bitcoin gives us a vision of a better future without a government that has a monopoly on violence and dispossession. We are not dependent on government-backed money anymore through Bitcoin and this has set the stone rolling to become independent of central authorities in all ways.

“You never change things by fighting the existing reality. To change something, build a new model that makes the existing model obsolete.” By Buckminster Fuller

This picture relates to the concept of “free private cities” as developed by Titus Gebel in the specialized form of Bitcoin citadels

Note: The value of Bitcoin is rooted in its scarcity and decentralization. No central party may create money out of thin air but instead, new bitcoins can be only created in a process called “mining.” Explaining the value of Bitcoin in depth would go beyond the scope of this article — however, this will find its place in future articles.

Great thanks to my proofreader Márton Csernai and Keyvan Davani. My great appreciation also goes to Alexander Bechtel for supporting me in my process of going down the fiat rabbit hole through our conversations and chats.


Central banks’ monetary policy as a means for economic control was originally published in Coinmonks on Medium, where people are continuing the conversation by highlighting and responding to this story.