Thread by @CaitlinLong_

1/ GREAT ARTICLE abt how financial mkt plumbing really works, incl the real reason why Lehman failed & why the same probs still mostly exist: #rehypothecation + a shortage (!) of collateral despite frenzy of new govt debt issued. @JeffSnider_AIP @RaoulGMI realclearmarkets.com/articles/2020/…

2/ But lemme connect 3 dots abt how it relates to #crypto

* There's a SHORTAGE of collateral (T-bills, etc)--the stuff big dealer banks NEED in order to fund themselves. Facebook Libra/Diem could worsen that shortage a lot, so you can see why central bankers view it as a threat.

3/ The #repo mkt periodically has disruptions caused by collateral shortages/undercapitalization of the big dealer banks. @JeffSnider_AIP looks at March 2020 in this piece but many other examples exist, eg Lehman in 2008. When repo mkt seizes up, the probs ripple across fin mkts.

4/ So, it's a big problem when pools of T-bills & other #HQLA become squirreled away outside the banking system PLUS outside the reach of the #repo mkt. (I got to interview expert Dr. Singh of the IMF abt this on @RealVision.) For #crypto now, the issue is Facebook Libra/Diem,...

5/ ...but generally stablecoins issued by non-banks other than Facebook will eventually pose the same problem. These are small now but they've quadrupled since March & are still growing at that rate. Beware--big #stablecoin collateral silos would pose big probs!🧐🚧

Next point..

6/ * Earlier this yr I noted it was significant that a G-SIB moved the head of its #repo desk to run digital asset desk--in LONDON!😱@JeffSnider_AIP's article should connect the dot about London:

"Regulatory arbitrage in the presence of non-harmonised #rehypothecation regimes."

7/ Jeff's article explains it well (London doesn't limit #rehypothecation while US does--was true at time of Lehman & still true.) So...connecting dots...there's a collateral shortage, and #Bitcoin is pristine collateral,...and London allows unlimited rehypothecation...🤔

8/ As Gretzky said, you gotta skate to where the puck is gonna be, not where it is. It seems at least one G-SIB is indeed doing that. This isn't just abt #bitcoin--bc #stablecoins issued by banks (NOT non-banks) are coming to #repo mkts too. #Wyoming figured this out 2 yrs ago..

9/ ...and that's one reason why #Wyoming set up a special, non-lending type of bank charter (#SPDI) designed to bridge #crypto & traditional mkts responsibly. The US needs that. Why? It connects to my last point:

* BEWARE: #crypto & leverage don't mix. 🚧🚨

10/ ...@JeffSnider_AIP's piece gives background--there's big leverage in #repo mkts + the length of collateral chains isn't clear. So why can't this mix w/ #crypto? Bc there's no lender of last resort in #crypto + crypto trades settle in minutes w/ irreversibility. So different!

11/ IMHO there's ONLY ONE way to mix #bitcoin & leverage in a compatible way that doesn't pose financial stability risk: set up special-purpose, ring-fenced, non-leveraged banks w/ a collateral chain limited to 1x (ie, no #rehypothecation). In other words...

12/ ...#rehypothecation & #bitcoin don't mix!

(Rehypothecation + bitcoin + leveraged G-SIBs ESPECIALLY don't mix!!🚧)

Mixing bitcoin & leverage is hi risk (both hi loss probability + hi loss severity)--no LOLR, fast settlement w/ finality.

As G-SIBs enter #crypto they will..

13/ ...want to use these new assets to alleviate #repo mkt's collateral shortage. I've been thinking abt how to marry #crypto & trad financial systems for yrs & I think only #Wyoming has legal & regulatory regime to do it in right way so far. And that includes #custody.

14/ ...Others will catch up, I'm sure. And that will be good for everyone. There's too much at stake to get this wrong!!

PS--here's my interview w/ Dr Manmohan Singh on @RealVision abt collateral re-use. We don't always agree but he has taught me a lot!🙏realvision.com/caitlin-long-a…