Thread by @fraser_again

1/ Talk about #proofofreserves /liabilities/solvency as the solution to @FTX_Official misses the surrounding parts which could make crypto a viable alternative to the fiat system. Join as we journey through:

☑️ Quality of reserves
💸 Capital &💧liquidity
💰 Collateral

#FTX

https://twitter.com/MarioNawfal/status/1591483648024494081

2/
🧾 Transaction histories and 💳 Credit scores
％ Fractional banking
🪙 New money creation

with a little bit of:

🆔 @w3c Verifiable Credentials #W3C

to build consumer protection and stop this happening again🛑. It's going to be a long one, strap in!

#FTXScandal

3/ Let's start with ☑️ Quality of Reserves. This is covered excellently by the @FT below so pulling out the key pieces from FTX 👇

https://twitter.com/FinancialTimes/status/1592102587083329536?s=20&t=-6kgdzeoDbkhF2A6UJ0Hbw

#cryptosignals #ftxbankruptcy #ftxwithdrawal

4/ From the FT's analysis, FTX held less than $900mn in "easily sellable assets" with $470mn being @RobinhoodApp shares ($HOOD).

$2.2bn of FTX's not "easily-sellable" assets were in @ProjectSerum ($SRM) with a current market cap of $72mn, fully diluted market cap of ~$2.8bn.

5/ In short, a market nowhere near liquid enough to absorb $2.2bn of sell-off from FTX.

This is where proof of reserves needs to take into account the quality of the "easily sellable" asset. Per the FT's analysis, $SRM & others weren't liquid enough to be included. #liquidity

6/ Let's compare @cryptocom and #USDC reserves as an example.

@kris has kindly provided #CryptoCom 's reserves (link below):
~28% $BTC, $22% $SHIB, ~16% $ETH, ~10% USDC, ~5% USDT, 19% other

portfolio.nansen.ai/dashboard/cryp…

7/ #USDC on the other hand is entirely backed by cash and short-dated US Treasuries.

centre.io/hubfs/USDC%202…

8/ Both @cryptocom & $USDC's reserves are highly liquid, with USDC's cash and US Treasuries the most liquid market.

Whilst #$BTC et al are highly liquid, their value can fluctuate significantly, affecting their function as reserves, i.e. similar issue as $FTT to a lesser degree.

9/ We therefore need some independent measure of Reserve Quality, similar to @coingecko and @CoinMarketCap 's trust scores for exchanges:

coingecko.com/en/methodology

Only stating reserves simply isn't sufficient.

10/ Closely related to ☑️ Quality of reserves are 💸 Capital & liquidity #regulations or guidelines.

@cz_binance has already pointed out exchanges shouldn't run on fractional reserves:

https://twitter.com/cz_binance/status/1590055819416330240?s=20&t=-6kgdzeoDbkhF2A6UJ0Hbw

11/ This makes a lot of sense, but what about crypto-lenders?

Banks typically operate to two requirements:
- 💸 Capital requirements
- 💧 Liquidity requirements

12/ Taking 💸 Capital requirements first, Large Banks (>$100bn) are expected to maintain a capital to risk-weighted-asset ratio (>4%).

federalreserve.gov/supervisionreg…

This is ％ fractional reserve banking, we'll return to this.

13/ Similarly, they are expected to meet certain liquidity requirements, i.e. holding sufficient high-quality liquid assets to cover net outflows over 30 days under a stressed scenario under Basel III:

en.wikipedia.org/wiki/Basel_III…

14/ And highly relevant here, where @SBF_FTX loaned ~$8bn from FTX to @AlamedaResearch is ringfencing. In short, ringfencing is splitting retail (borrowing and lending) from other activities).

bankofengland.co.uk/prudential-reg…

15/ This was implemented after the 2008 financial crisis to prevent impact to retail customers.

Maintaining ringfencing for the exchange business would have prevented FTX loaning customer deposits across to Alameda to cover their liabilities.

16/ Across #proofofsolvency, capital & liquidity requirements and ringfencing, there is plenty which can be proven on-chain as @cryptocom and @binance have done, there is plenty off-ledger which needs observing and proving, such as arms length relationships between businesses.

17/ This is where independent auditors (there's a seperate thread here on auditor incentives sometime), ongoing monitoring and opinions as #VerifiableCredentials come in.

On-ledger proofs with off-ledger opinion credentials can be combined into a more thorough trust-score.

18/ The beauty of blending on-ledger proofs (reserves / liabilities / solvency) with independent auditor opinions issued as Verifiable Credentials (VCs) means the entire system can be decentralised, without the need for a central authority.

19/ Brief aside on Verifiable Credentials (#VCs):

They allow any recipient to check that the information they have received came from the right place (e.g. auditor) and is current (i.e. not out of date) so the information can be trusted.

20/ This potentially opens up #trusteddata marketplaces for this information and the aggregation of it into something easily understood by users so they can make informed decisions about where and how they trade through decentralised reputation. (like we're building at @cheqd_io)

21/ We need consumer protection, making trusted data available. As a community we should expect similar standards to avoid repeats of FTX, @CelsiusNetwork and expect transparency to measure risk.

The guidelines are there, we just need to use / expect them. #consumerprotection

22/ The other obvious shift following this drama, is the move towards DEXs with the transparency they provide, best demonstrated by @Flowslikeosmo using @osmosiszone here:

https://twitter.com/Flowslikeosmo/status/1591959234043789313?s=20&t=0gT2Dfy8FxyHVG9kgwOU-g

#DEX

23/ Now to💰 Collateral,🧾 Transaction histories and 💳 Credit scores as these are all inter-related and relevant to centralised and decentralised alike.

In the same way CEX's and lenders are using their tokens as Reserves, these are often used as Collateral for lending too.

24/ There are multiple reasons for this. Let's first look at the lack of transaction histories and credit scores.

Both centralised and #DeFi lenders are operating without a lot of information on users and their histories, especially the ~1b incoming users over the 10 years.

25/ Without a good picture of risk for a borrower, the lender has to be cautious which has led to collateral ratios of >80% (e.g. Aave, link below).

coinmarketcap.com/alexandria/art…

26/ These high collateral ratios drive need for capital which is easier to find in non-stable coins, leading to even higher collateralisation ratios (>200%) due to token volatility as shown by BIS here:

bis.org/publ/bisbull57…

27/ Instead by consuming 🧾 Transaction histories or potentially bringing in traditional 💳 Credit scores, lenders (centralised or DeFi) can know more about borrower's risk and therefore reduce collateralisation ratios, the need for capital and enable higher quality collateral.

28/ As with auditor opinions on reserve quality, etc, reputation and credit scores can be brought into the ecosystem via privacy-preserving VCs so the user is in control but can access better products / terms.

29/ By driving down collateralisation ratios, lenders can shift to a ％ Fractional reserve banking model, which enables 🪙 New money creation through depository multiplication.

en.wikipedia.org/wiki/Fractiona…

30/ Taken together, all of these mechanisms provide the framework for crypto to create New money 🪙 and fulfil one of the key functions of the #fiat system, addressing a current limitation whilst building on solid foundations.

31/ Finally, we see Verifiable Credentials (👆 /19) and decentralised reputation as being key parts of establishing strong consumer protection beyond #proofofreserves and in enabling more efficient lending markets, specifically to create safe New Money 🪙
#decentralisedreputation

32/ If you believe in the future we've outlined above and want to help build it, get in touch! #WAGMI