The year 2022 was marked by many twists and turns, the repercussions of which made it possible to refocus on one of the pillars that Bitcoin (BTC) offered us: control of our funds. Through all the solutions offered by crypto-asset trading platforms and other “CeDeFi” type platforms, would we not have wrongly freed ourselves from the inseparable and essential base that this technology offers us?
Benjamin Franklin warned us
” Those who can give up essential freedom to buy a little temporary security deserve neither freedom nor security. “. This quote sounds like a prophecy given the events that marked the cryptocurrency ecosystem in 2022.
Figure 1 – Benjamin Franklin
Everything seemed simple, however: it was enough to first bet on any platform listing the famous and now fatal stablecoin UST of the Terra blockchain to benefit from returns giving migraine to our traditional banks. Because for many it did not involve the slightest risk, you see: it had even become the 3rd most capitalized stablecoin.
And the most seasoned controlled their funds anyway, because they went through the famous decentralized finance (DeFi). Intuitive and flawless, it became more accessible through great platforms like Celsius Network.
But there again, the fearful had only to entrust their funds to prodigies like a certain Sam Bankman-Fried, ex-CEO of FTX. A man of multiple superlatives, still praised not long ago. For example, he was seen as “one of the most talented traders”, a “philanthropist”, an “effective altruist aiming to direct his donations to sectors or associations whose data has been scrupulously analyzed”.
How could there have been eels under rock? No reason to worry, the “crypto” sector does not (yet) have the vices of large banking institutions like Credit Suisse or Silicon Valley Bank.
Diamond and Dybvig, the reference that should have guided us
Douglas Diamond and Philip Dybvig are two economists who co-authored the article entitled “Bank Runs, Deposit Insurance, and Liquidity” in 1983. They were only doctoral students when it was written, and yet it will become a classic of economic literature, often cited as a reference around the issue of financial systems and banking stability.
The main theme evoked is that of “bank runs”. The authors offer a theory on how deposit guarantees (which are depositor compensation guarantees in the event of bank failure) can contribute to the stability of financial systems.
Indeed, these mechanisms would avoid temptations for customers to withdraw their funds when a bank run occurs. They also use mathematical models to explore the potential costs and benefits of these guarantees and available liquidity.
In detail, they describe a postulate that may appear quite intuitive: the potential liquidity needs of lenders compared to the financing needs of borrowers structurally place banks in a position of illiquidity.
They describe in detail a postulate that may appear fairly intuitive: the potential liquidity needs of lenders compared to the financing needs of borrowers structurally place banks in a position of illiquidity. pic.twitter.com/KcoxTzDQGU
— Orka (@orka882) September 26, 2022
To put it simply: banks receive deposits that can be withdrawn at any time. The banker will lend this money to investors who have more or less long-term needs, but who will bring returns only in the more or less near future.
It is precisely this characteristic of bank balance sheets that makes banks vulnerable to bank runs, but in theory can bring about an improvement in social welfare (by allowing more people to invest in long-term projects).
They then define two types of profile: the “patients” and the “impatients” who will be led to share the risks. :
Without the banks, the impatient people who need liquidity quickly would have to either give up on their projects or invest in low-paying short-term projects; Patients, on the other hand, could afford to invest in the long term in more profitable projects, but would not have the guarantee of being able to withdraw liquidity in case of urgent need.
The risks are thus shared : patients can recover liquidity at any time if needed and the impatient have a possible and higher return. In theory, the volumes of liquidity in play normally make the equilibrium robust. The problem is that everyone is officially able to withdraw their liquidity.
🎁 Cryptoast Research Launch Offer
1st Newsletter Free with the code TOASTNL
Too big to fail. Except Lehman Brothers. Except Northern Rock. Except Silicon Valley Bank. Except Credit Suisse…
The rest of the reflection on bank runs is based on the study of possible scenarios, which are described by the authors.
The elements are as follows: a critical economic context, a rumor about the insolvency of an establishment (true or false) or even a first liquidity crisis of another equivalent establishment. The two authors of the article then describe phenomena of self-fulfilling prophecies and the effects that doubts have on a bank’s ability to repay its depositors.
The different profiles will then be tempted to go to the counters to withdraw their cash.aware that they will have even less chance of finding them if they arrive late at the bank.
Figure 2 – Crowd at the American Union Bank in New York during a bank run at the start of the Great Depression
What is the proposed solution and the conclusion of the reflection?
The suspension of the convertibility of deposits or the establishment of a public system to guarantee them is put forward.
The introduction of a tax on withdrawals made within too short a period of time after deposit is the second option for them.. This would really deter agents from panicking and more specifically, prevent “patient” agents from behaving like “impatients”.
This is how, in particular, in Europe, Member States of the European Union are required to guarantee bank deposits up to 100,000 euros per bank and per depositor in accordance with European Directive 2009/14/EC. Interesting to note: the authors specify that “the establishment of a deposit guarantee system could lead depositors to lower their vigilance with regard to the activities of their banks, which could encourage them to take more risks “.
How to interpret the message? Here is a possible transcription “banks are dangerous, but provide a service that makes sense in our societal context and in strong economic times. Each added security actually increases their power and gives the illusion that they are indispensable and without risk. »
There are indeed many examples of bank runs. : crisis of 1907 in the United States (which led to the creation of the American Federal Reserve), banking crisis of 1929 responsible for the Great Depression, Greek banking crisis of 2015…
In their wake, banks like Lehman Brothers, Washington Mutual, Wachovia, Northern Rock, Dexia or IndyMac Bank found themselves in the same situation as Celsius Network or FTX.
It is funny to note, moreover, that the oldest bank in the world still in operation has also been bankrupt. This is the Banca Monte dei Paschi di Siena. Saved in extremis by the Italian government with taxpayers’ money in 2017. The longevity or seniority of an establishment does not therefore protect it from economic and financial setbacks…
Alyra, training to integrate the blockchain ecosystem ⛓️
Vincent Van Gogh, a wise Bitcoiner brings us the conclusion?
” I’d rather have a hundred francs with the freedom to do what I want than two hundred francs without that freedom.”. This quote from the artist with the mutilated ear perfectly illustrates the substance of the problem raised by the article.
Diamond and Dybvig highlighted the risks of bank runs as well as the need for security mechanisms such as deposit insurance to protect depositors. However, despite the measures they have inspired, financial crises continue to occur, which has prompted many people to look for alternatives.
Satoshi Nakamoto, the anonymous creator of Bitcoin, developed it in response to the 2008 financial crisis, which exposed weaknesses in traditional financial systems. The essence of his philosophy was to create an alternative decentralized system, allowing users to control their funds without having to trust a third-party financial institution..
It represents a necessary alternative, having no credible equivalent at present. Through the real control of our funds that it induces, it eliminates the systemic risks identified by the two academics by having advantages of transparency, security and immutability. In addition, its decentralization allows an emancipation of the trust that we are required to have vis-à-vis financial institutions.
If at the time of Van Gogh our ancestors only had the possibility of hiding their money under their mattress to emancipate themselves from it, we now have a real credible alternative.. You know what you have to do.
👉 Find our complete guide to buy Bitcoin
Buy crypto on eToro in minutes
Sources: Figure 1; Figure 2
Newsletter 🍞
Receive a summary of crypto news every Monday by email 👌
What you need to know about affiliate links. This page presents assets, products or services relating to investments. Some links in this article are affiliated. This means that if you buy a product or register on a site from this article, our partner pays us a commission. This allows us to continue to offer you original and useful content. There is no impact on you and you can even get a bonus by using our links.
Investments in cryptocurrencies are risky. Cryptoast is not responsible for the quality of the products or services presented on this page and could not be held responsible, directly or indirectly, for any damage or loss caused following the use of a good or service highlighted in this article. Investments related to crypto-assets are risky by nature, readers should do their own research before taking any action and only invest within the limits of their financial capabilities. This article does not constitute investment advice.
AMF recommendations. There is no guaranteed high return, a product with high return potential involves high risk. This risk-taking must be in line with your project, your investment horizon and your ability to lose part of this savings. Do not invest if you are not ready to lose all or part of your capital.
To go further, read our Financial Situation, Media Transparency and Legal Notices pages.
Still a layman of the cryptocurrency community a few years ago, I tend to browse an area in its entirety if I like it. From mining to decentralized finance via staking or masternodes, from now on I am committed to popularizing this universe in order to bring my discoveries to as many people as possible. Don’t forget your laser eyes.
Florian Bassegoda
4 items
