“Every trade makes us richer or wiser, but never both.”
— Investing proverb
It’s a Hard Knock Asset Class
The failure of Lehman Brothers was the most memorable event of 2008, but it was not the most dangerous event.
The most dangerous event was when the $65 billion Reserve Primary Fund, holder of a small amount of Lehman’s commercial paper, subsequently broke the buck.
Why would one money market fund falling a couple of cents below par be more dangerous than a major bank going to zero?
Becausethe biggest risk to markets occurs when what people think is money turns out not to be money.
People thought money markets were interest-bearing dollars, but for something to be money, it has to be redeemable at par at all times — most of the time is not good enough.
Which is why the Reserve Primary Fund trading just three cents below par threatened to break all of TradFi — it was the moment that savers learned that money markets are not money.
But we didn’t really learn that lesson, because the Fed promptly stepped in to protect us from it, underwriting every money market fund in the country.
For us to fully learn that lesson, the market may have had to break, which the Fed wasn’t willing to risk.
Getting Wiser With DeFi
In crypto, by comparison, the lessons are harder learned — and all the more valuable for it.
There have been a lot of these lately, mostly from a non-stop drumbeat of hacks, rugs and semi-Ponzis.
It hasn’t been fun, but I’d argue that each one has made the system a little more resilient.
This week we’re learning about stablecoins.
UST, the crypto equivalent of a money market fund, has traded down not just a couple of cents, but all the way to 70 cents and back up to 90 cents — transacting billions of dollars of volume along the way.
What have we learned in the process?
It’s too early for postmortems, but we may be learning that DeFi is anti-fragile in a way that TradFi is not.
That is partly because we already knew that algo stablecoins are not really money. We learned that just a year ago when IRON Finance failed.
Interestingly, IRON, the stablecoin, now trades comfortably at $1 while TITAN, the governance token, is a zero.
IRON admittedly has a microscopic market cap, but I think there’s a lesson here anyway: If UST survives the week, it may mean that stablecoins don’t necessarily have to be stable — perhaps they can float away from peg for a while and then regain it at a later date.
A floating stablecoin would be disqualified from being considered money, but may still have its uses.
That may prove over-optimistic, but we at least now know that a large-cap algo stablecoin, lightly collateralized by a floating asset (BTC) and a crashing governance token (LUNA), can somehow get back within spitting distance of its peg.
And other than LUNA, nothing in crypto has really broken.
More Lessons Coming?
Some are concerned that losses incurred by hedge funds in UST and LUNA could ripple through to the rest of crypto and possibly bring down the whole asset class.
But Alameda and Jump — the two funds most often cited — are not Lehman Brothers.
Lehman was led at the end by a delusional CEO with little understanding of the giant risks his bank was taking.
I think it’s safe to say that the likes of Alameda and Jump know exactly what risks they’re taking — I’d be surprised if they didn’t both end the week with a positive P&L.
As for the rest of us, Terra is not the Reserve Primary Fund — no one should be surprised that UST has turned out to not be money.
That's partly because the user experience in DeFi remains janky, to put it politely.
If you navigated your way into UST, LUNA, Anchor or Astroport, you probably know enough about crypto to be unsurprised that an algo stablecoin has lost its peg.
So it’s a good thing that the barriers to entry remain high in DeFi: There are no widows or orphans, depending on Anchor’s 18% semi-Ponzi yield.
If Terra USD fails, the harm done should be minimal.
Which is not to say we are out of the woods yet — this is a developing story.
MicroStrategy fell 25% yesterday, reflecting the risk that selling by LFG could push bitcoin to a level that would trigger margin calls on one of bitcoin’s largest holders.
And I may be underestimating potential damage to crypto funds: Fireblocks recently said it had $500 million of inflows into the Terra ecosystem as soon as it offered its customers access.
In both cases, I’d say it’s fortunate that the UST de-peg happened now and not, say, six or nine months from now when LFG owned more BTC and crypto funds had more exposure to Terra.
We are getting wiser in crypto, and it’s good to do so sooner rather than later.
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