In the Blind Spot (Terra, Diesel, Cartels)

Housekeeping note. I have been traveling this week (and am currently in Poland for a conference) hence the giant content hole. 

Finance, economics, markets etc…

• Is the Terra fail a Lehman moment for crypto?
  

  I have been travelling so I haven’t been able to keep up with the Terra debacle as well as I would have liked to. The good news is, I should have a broader piece about this by the weekend. In the meantime what I will say is that I was one of the first mainstream journalists to write about the market risk being introduced by crypto stablecoins. From the beginning I likened them to MMFs or eurodollar-style liabilities. You can read my initial account of the dawning of the Tether phenomenon here. As I noted at the time (my emphasis):

  “Today Tether remains — at least on paper — a fully reserved dollar-backed system, anchored to the US dollar-issuing banking system. Theoretically at least, however, there’s no reason why it can’t evolve into something more akin to Alibaba’s Yu’e Bao fund, the largest money market fund in the world, which manages its RMB peg through active asset management. In the crypto world, of course, some share of assets could theoretically be other crypto currencies or ICOs. While the risk of asset swapping in this way would obviously be huge, it’s nothing ETF managers or Delta One desks haven’t tried before. It is, as it has always been, a question of marking everything to market and hoping both liquidity and correlation sticks.

  Terra was “different” in that it was allegedly backed by an algorithm. But this of course was always pure marketing. It wasn’t really backed by an algo. It was backed by an arbitrage which emulated a perpetual value-creation motion machine. The problem is, that perpetual motion machine was illusory, and entirely dependent on constant liquidity in Terra and its value-skimming counterpart Luna.

  Being dependent on “liquidity”, however, is also just a euphemism for being dependent on there always being as many people in the market wanting to buy your asset as there are wanting to sell it. Liquidity disappears when there is a big imbalance either way. This is a known known risk. The fact that anyone could have been dumb enough to think you can algorithmically control for it speaks volumes about the naiviety underlying the stablecoin market.

  What’s more, whether the founders knew it or not, they were synthesising a type of central bank relationship that depended on sophisticated forecasting and signalling. These sorts of relationships are always subject to reflexivity and blowback. In Terra’s case, what was supposed to be a confidence building exercise in accumulating a bunch of bitcoin reserves to help bolster the value of Terra, probably sent the opposite signal to the market. Notably, it suggested there was a risk the stablecoin might have to draw on such assets, meaning the founders’ confidence in the algorithm wasn’t 100 per cent. This introduced a known known reaction pathway that could be arbitraged. Undoubtedly it will also have influenced the valuation of Terra and Luna itself, adding decorrelation risk.

  What’s really cute, is that the crypto community is referring to the unstitching of the peg as a hacker style “attack” on the stablecoin. But by all accounts the “exploit” was simply the unpicking of a poorly constructed value system through a legitimate arbitrage-exploiting exercise.

  I love that the worlds of crypto and finance have now collided in such a way that we can finally expose everyone engaged in arbitrage hunting, from Paulson to Soros, as nothing more than a hacker.

  (Of course there is an element of truth to this. Good traders look for bad value assumptions or vulnerabilities in current arbitrage mechanics. They then exploit them and make squillions. This is seen as an exercise in making the market more efficient in the long run. As a result, I think this fusing of terminologeis tells us more about how we view computer hacking than it does trading. If most hackers — at least those who don’t depend on social engineering or disinfo — are just arbitrage hunters, it’s fair to say they have gotten a bit of a bad rap for exposing vulnerabilities and making the market more efficient. Though, I guess, that’s the point of offering hacker bounties in penetration testing environments.)

• Draghi floats creation of oil consumer ‘cartel’ after meeting with Biden.
  

  The idea of introducing a buyers’ cartel for energy markets has actually been floating around since at least March. Is it really that innovative? I don’t think so. As I noted back then, it mostly formalises the informal buyers’ strike that has already existed in the market since ESG became a thing. In the context of the EU specifically, it merely extends the longstanding EU policy of using collective bargaining power to achieve better pricing and protection of domestic markets.

  Is it likely to work? In theory, a buyers’ strike on essential goods like oil and gas can never be as powerful as the equivalent sellers’ strike. This is especially the case when those sellers can sell to another big market exclusively. What it really emulates is the Brexit negotiation process, but with the EU in the UK’s net importing position.

  The real bargaining chip the West has always had is being able to deny access to its own markets. We buy oil and gas from the likes of Russia and the Middle East, and pay for those commodities with hard currency which can then be used to access the high quality markets (from luxury goods and leisure to real-estate) of Europe. That is super appealing. Europe is lovely. Who doesn’t want to galavant around Europe?

  Problem is, we don’t have the exclusive monopoly on luxury and leisure anymore. The Middle East has invested heavily in turning its own territories into pleasure centres. As has China. Russia less so. But for as long as Russian oligarchs can still holiday in Dubai or Asia, it’s not the threat it used to be.

• The diesel shortages are getting bad.
  

  This, in one picture, is why we don’t have the clout we think we have. As Bloomberg reported:
  “I wouldn’t be surprised to see diesel being rationed on the East Coast this summer,” Catsimatidis, CEO of United Refining Co., said in a phone interview. “Right now inventories are low and we may see a shortage in coming months.”
  As you know, I am in Poland right now. The anti Russian sentiment here is about 10x what it is in the UK. The desire across the board is firmly for MORE sanctions. There is little concern about the longer term consequences of fuel shortages, mostly because everyone is convinced Poland can burn coal to compensate. But coal can’t be turned into diesel! Even informed commentators seem hugely ignorant of the second order consequences. They seem entirely blinded by passion.