Neither a Crypto Borrower nor a Lender Be

Image credit: Diverse Stock Photos || Would that those shiny coins were the real thing. Metal coins are real. Code, not so.

As I have said before, look at the underlying economics of an investment rather than its external form. It doesn’t matter whether it is public or private. The form of an investment does not affect its returns, for the most part.

I grew up in investing as a risk manager within life insurance and fixed income. We faced three main risks: credit, liquidity, and duration. We had lesser risks as well, like FX, sovereigns, convexity, etc. My main goal was to see the firm survive under all reasonable circumstances. My secondary goal was to improve profitability over those same circumstances.

In doing that, we could make some small “side bets.” Buy an underpriced Canadian dollar bond. Buy a broken convertible bond of a beaten down company. Buy underpriced MBS where the models are overstating refinancing risk. Things like that. We could not make those side bets too large, but we could put a few on to try to make some money for the firm.

We would match assets against our likely liability cashflows. We knew that 99%+ of the time, we would be fine.

I can’t imagine what the so-called crypto banks are thinking. Much as they deride banking generally, they don’t have the vaguest idea of what they are doing. They should hire an investment actuary to limit what they do.

Imagine a world where banks don’t care about currency risk, and some fail because the temptation to reach for yield causes them to buy asset in currencies that are weak… leading them to lose capital on net.

This is the nature of crypto lending and borrowing. As Aristotle might have said, “Crypto is sterile.” It doesn’t produce anything. So don’t lend out crypto for a return… you may lose you principal in the process. There is no good reason why you should earn a return exceeding Treasuries plus 1% in lending crypto.

But no one in crypto considers risk control. In one sense, I’m not sure how it could be done, unless you limit yourself to one major cryptocurrency — Bitcoin or Ethereum.

The grand questions should be:

• Can I be sure of making payments over the next three months?
• Is my leverage low enough that the mélange of assets that I own will be able to cover my liabilities?
• Is there anything I can do to promote long-term survival?

With cryptocurrency banks and stablecoins these concerns are ignored. They take risks that no bank or insurance company would take and with far less capital than would be reasonable.

I encourage you to sell your crypto and buy gold, stocks, bonds, and other dollar-denominated assets.