The U.S. Banking System, Federal Reserve, & USDC Post-SVB Collapse with Ram Ahluwalia

Ram Ahluwalia, CEO of Lumida Wealth Management, joins us to discuss everything that's happened in the past five days post-SVB collapse. Ram has his finger on the pulse on all things finance (crypto included), the U. S. Banking System, and The Federal Reserve. Was USDC ever at risk? Is crypto being targeted? Could DeFi have fixed this? Answers to these questions and much more in the episode. ------ 📣 RhinoFi | Makes DeFi Frictionless https://bankless.cc/rhino ------ 🚀 JOIN BANKLESS PREMIUM: https://www.bankless.com/join ------ BANKLESS SPONSOR TOOLS: ⚖️ ARBITRUM | SCALING ETHEREUM https://bankless.cc/Arbitrum 🐙KRAKEN | MOST-TRUSTED CRYPTO EXCHANGE https://bankless.cc/kraken 🦄UNISWAP | ON-CHAIN MARKETPLACE https://bankless.cc/uniswap 👻 PHANTOM | FRIENDLY MULTICHAIN WALLET https://bankless.cc/phantom-waitlist 🦊METAMASK LEARN | HELPFUL WEB3 RESOURCE https://bankless.cc/MetaMask 🚁 EARNIFI | CLAIM YOUR UNCLAIMED AIRDROPS https://bankless.cc/earnifi ----- Timestamps: 0:00 Intro 7:48 The Last 5 Days 10:30 Technology 15:35 Fractional Reserves & Assets 19:17 Banking & Venture 21:44 SIVB Outlier 27:35 Risk Curves 29:35 Carry Trades 35:05 Money Markets 38:15 Who's Next? 40:55 Feds' Goal 47:15 Sneak Attack on Tax Payers? 49:30 Longtail Banks 57:39 Was USDC Ever at Risk? 1:03:10 SigNet 1:07:15 Is Crypto Being Targeted? 1:12:18 Interest Rates 1:18:35 Could DeFi Fix This? 1:22:24 Closing & Disclaimers ----- Resources: Ram Ahluwalia https://twitter.com/ramahluwalia SVB is not like other banks https://twitter.com/ramahluwalia/status/1635464465142480896 Why was Signature Bank targeted? https://twitter.com/ramahluwalia/status/1635267951610810370?s=20 “Settlement Risk” https://twitter.com/ramahluwalia/status/1635113232909373441?s=20 Conclusion https://twitter.com/ramahluwalia/status/1634203375880265730?s=20 ----- Not financial or tax advice. This channel is strictly educational and is not investment advice or a solicitation to buy or sell any assets or to make any financial decisions. This video is not tax advice. Talk to your accountant. Do your own research. Disclosure. From time-to-time I may add links in this newsletter to products I use. I may receive commission if you make a purchase through one of these links. Additionally, the Bankless writers hold crypto assets. See our investment disclosures here: https://www.bankless.com/disclosures

Speaker names marked ? are inferred from speaking time and the show’s known hosts — they are not voice-verified.

• 0:15Ryan Sean Adams?

  Bankless Nation, we have a special state of the nation for you today. Got to talk about the banking crisis that happened last weekend. I think, David, this week, we're in a whole new world. A lot has changed. We want to dissect what happened and what's changed, what this means moving forward. And we brought on an adult in the room, someone that understands the financial system and the banking system much better than you and I do, or maybe than we ever will, and also understands crypto. What are we getting into today, David?

• 0:47David Hoffman?

  Yeah, the really, the big question is, are we in a new market? Did something change fundamentally? This, this throws me back all the way back into, I think, January of 2022, where I remember Jim Bianco tweeting out that we have entered a new paradigm, and that was the rising interest rates of the Federal Reserve. And I didn't really understand the significance of that phase change of markets, yet Jim Bianco called it like a nail on the head all the way back then. And so now I'm wondering, and now I think the market is wondering is, are we entering a new type of phase change in the market? Bank stocks were down across the board yesterday. Crypto started responding in like a logical fashion, which is like, even though it's

• 1:31David Hoffman?

  logical, still new and different. And so I think this is the big question that we really want to, to really ask is, what has changed? Is there a structural difference in the world of investing these days?

• 1:46Ryan Sean Adams?

  And David, it's not just you and I in this episode. Who do we have on to tell us that story?

• 1:51David Hoffman?

  Yeah, we are bringing on Ram Ahluwalia, who's the CEO of Lumina Wealth Management. We will introduce Ram shortly in a little bit, but we were, I asked Matt Walsh, our friends over at Castle Island Ventures podcast, who should we bring on? And so Matt suggested Ram. And so Ram actually had a Twitter space. This last weekend, during the middle of this confusion that was very insightful for me and put a lot of perspective into my brain. So shortly, we will be bringing Ram on here in a second.

• 2:20Ryan Sean Adams?

  Guys, before we get in, I want to tell you about our friends and sponsors, RhinoFi. Embrace the inner Rhino. All right. This is a DeFi platform. So none of this behind what I'm showing you on the dashboard here, none of this is custodial. This is an overlay on top of decentralized protocols. David, tell them what RhinoFi is up to and how folks can get started with this really cool application.

• 2:45David Hoffman?

  Well, while we have trad banking totally breaking down, we have new banking, which is bankless banking across all of these different chains. And that's really what RhinoFi enables you to do. All of the many different chains with all of the many different verbs that one might engage with as they do their bankless banking activities. All so all these different chains on one space and you can do all the things that you like to do, trade, swap, invest, pool, bridge, send, all the verbs on the left. And it obfuscates and abstracts a lot of the complexities that one might engage with while they are going across the multi-layered to multi-chain vision. So there's a link in the show notes to get started. You can also go to app.rino.fi

• 3:26David Hoffman?

  to start working in the bankless world of banking, because sooner or later, it sounds like we all might need it these days.

• 3:32Ryan Sean Adams?

  That's why we're all here, isn't it? To go bankless. This is a way to do that. Go check that out, rhino.fi. David, what should folks get out of this episode? What should they pay attention to as Ram speaks today?

• 3:44David Hoffman?

  Yeah, so there's a bunch of big overarching headlines, and I think we're going to try and touch on one by one by one. One is bank runs in the internet age. Is that the new arena that we have stepped into? Was Silicon Valley Bank a special case? And in what ways was it not a special case? Signature Bank, why was it targeted? What is the impact on crypto? How is this changing the landscape of banking altogether? Yields are down, fear is up. Is that a temporary blip or is that a complete and utter phase change in the market? I think these are all very big, important questions. And the answers to these things are really going to determine what the world of investing is like going forward.

• 4:27Ryan Sean Adams?

  As always, guys, we are learning as we go. We are on the journey with you, okay? And if this is a phase change, we need to know change because we need to know about it. We start every episode. This is front-running the opportunities. So what is the next opportunity we need to front-run? And what do we need to watch out for? That's what we'll get into right after we hear from the fantastic sponsors that made this episode possible, including Kraken, our number one exchange for 2023. Guys, these folks have been with you since 2011. Go start an account with Kraken.

• 4:58David Hoffman?

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• 5:41David Hoffman?

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• 6:26David Hoffman?

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• 7:09David Hoffman?

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• 7:49Ryan Sean Adams?

  We are back with Ram Ahluwalia, who is the CEO of Lumina Wealth Management, which is an investment advisor specializing in investing in digital assets. He's a self-professed elder millennial. I subscribe to that title as well. Ram, we've got to keep the younger millennials in line from time to time, as you know.

• 8:10Speaker 02

  Sure you don't mean me.

• 8:11Ryan Sean Adams?

  Yeah, not at all. But it's great to have you on, Ram. Thank you for joining us. Can you help us make sense of what just happened in the past five days?

• 8:20Speaker 02

  Happy to lay it out, and thanks for having me. Longtime Bankless Premium subscriber, big fan of the work that you do, week in and week out. So let's take a step back. What we've seen is the demise of internet banks. These are banks born of the internet and destroyed by the internet through social media, the speed of information contact, and digital withdrawals. So those banks started with, of course, Silvergate, Silicon Valley Bank, which were highly indexed to technology in the crypto sector, and of course, Signature Bank. So three banks in one week that are either in liquidation or in FDIC receivership. And to put it in context, at the last time we had a major bank run, it was in 2008, and

• 9:05Speaker 02

  it was in the UK. It was Northern Rock Bank. They had lines around the block, physical lines. And in today's world, you have digital bank runs that are enabled by better UX, where you can put a wire transfer online. And the fragility that the public has confidence in their bank can help to accelerate these bank runs. I'll pause there.

• 9:29Ryan Sean Adams?

  So Ram, you're saying that this is maybe the world's first large example of a digital bank run. That's, that's how you see the events of the past, you know, five days to a week or so.

• 9:40Speaker 02

  That's correct. It's, these are digital wire transfers. Now, there's some other special circumstances around this. So the three banks were primarily commercial banks as opposed to retail banks, and that matters for a few reasons. One is, as you know, the FDIC insurance cap is up to $250,000 and commercial deposits from a crypto venture fund, hedge fund, protocol, VC, et cetera, is well in excess of that. So there's a higher propensity for depositors and commercial depositors to panic if they believe their bank is not going to be safe and sound.

• 10:16Ryan Sean Adams?

  And Ram, commercial just means not retail, more business focused.

• 10:20Speaker 02

  That's correct.

• 10:21Ryan Sean Adams?

  Larger account holdings in general, usually above 250K because they're trying to meet payroll, that sort of class.

• 10:27Speaker 02

  Exactly right.

• 10:28Ryan Sean Adams?

  Bank user.

• 10:29Speaker 02

  Business startups, venture funds, hedge funds, exactly.

• 10:33David Hoffman?

  And part of the crazy story that we're going to be talking about is the multivariate nature of it. There's like interest rates. There's Elizabeth Warren to talk about. There's all these things, but I would, I really want to just carve out and silo off this, this topic of conversation of internet banking in the age of the internet era and social media, right? Just the, the connections that I'm, I've been seeing being made here is that the pipes for, for fitting a bank run through are larger than they've ever been before, as well as the virality of social media is larger than it's ever been before. So forget crypto, forget inflation, forget interest rates, forget political targeted

• 11:15David Hoffman?

  sectors of, of banking. We are simply just talking about the modern day technology of banking is probably the most susceptible to a bank run that they've ever been before, ever, just by in nature of that's what happens when technology progresses. That's like one big pin in the story, correct, Ram?

• 11:31Speaker 02

  You nailed it. These are banks born from the internet. They were destroyed by the internet. And banks rely on public confidence. In the United States and across the world, we have a fractional reserve banking system. No bank can survive a full-fledged bank run.

• 11:47Speaker 02

  By design. By design. Banks are one of the few entities that deliberately engage in borrowing short, lending long, and have the backing of a centralized authority, in this case, the FDIC and the Federal Reserve. Banks are doing liquidity, credit, and duration transformation. It's a kind of a financial alchemy. And you've talked about aspects of this in your prior podcast around money and the history of money and all the rest. But maybe I can just walk through a quick contrast of what banks do and then I'll tease up the kind of the multivariate cool. issues that you laid out, David. So let me contrast a securities brokerage account from a bank account. When you have a brokerage account, let's say Charles Schwab, let's say you own some stock, Tesla, Apple, et cetera.

• 12:31Speaker 02

  Those securities are custodied by Schwab or maybe BNY Mellon, the DTCC. And they're not in general being lent out. In fact, you can have those securities delivered to you to your door if you want. On the other hand, when you make a deposit at the bank, the bank reports to you that you've got, say, a $10,000 cash deposit. Now, the reality is banks and these custodians are very different. Banks behind the scenes are rehypocating. What that means is they're taking your deposits and of course they're lending out. And what the banks are doing is they're giving you instant liquidity. You have a demand deposit. You've actually made a loan to the bank that's a perpetual loan, that's priced at par,

• 13:14Speaker 02

  and has the perception of no credit risk and a zero duration loan. But on the back end, what is the bank doing? The bank is making longer derated loans. Those loans are illiquid. And therefore, the banks are engaged in this kind of like a financial alchemy of liquidity transformation, maturity transformation, meaning longer term loans, and credit risk transformation. You have the perception of no credit risk, but in fact, they are taking on some risk. And the way this financial alchemy or this kind of magic works is you need two things. You need to prevent bank runs. And the way we do that in the United States is FDIC deposit insurance.

• 13:56Speaker 02

  And we learned this from the Great Depression when there were a number of bank runs that caused the Great Depression. If you can stop a bank run by guaranteeing deposits, then the magic show can go on. And the second thing you need is a central bank like the Federal Reserve that can provide liquidity to the asset side of the bank's balance sheet. If you have those two things, then the banking system should work. And I'll say one other comment. What you saw in crypto the last two years was non-banks pretending to be banks. If you want to explain the failure of Voyager, Celsius, BlockFi and Genesis, what were they doing? They were taking short-term deposits. They were lending long. It's great to be a bank, but it doesn't work if you get a bank run.

• 14:39Speaker 02

  So for example, Genesis couldn't sell their illiquid assets in time. They also got caught up in this asset duration mismatch.

• 14:48David Hoffman?

  So with all the solvency's that insolvencies, whether inside in crypto or now that we're seeing them outside of in crypto, you're saying it's the same underlying pattern through and through. So the insolvencies of Celsius, regardless of the mismanagement of Celsius, the insolvencies of Celsius, Genesis, et cetera, all the crypto firms that have already happened. Now we've seen them in three banks. But you're saying the underlying structure is still the same. There's people that had instant obligations while they were also taking long-term stances in the market.

• 15:20Speaker 02

  Yes, when non-banks pretend like banks, watch out because when the cycle turns and liquidity leaves the system, you're going to see us naked. Now, obviously, there was fraud in the case of Celsius and other actors as well.

• 15:32Ryan Sean Adams?

  Can I ask a question, clarifying question about this, Ram? So, all right. So fractional reserve means if everyone tries to withdraw their funds at the same time, it breaks down because there are assets there that have kind of longer maturities and kind of the money's not there because it's being lent out. And that's how the banking business model works. I got it. And that's true whether you're Celsius or whether you're Silicon Valley Bank. Understood, all right? But can you tell us about the assets that these banks are actually investing in? Because It's got to be different than Celsius and it's got to be different than BlockFi, right? So in the case of a Celsius or a BlockFi, they're investing in this, these highly volatile crypto assets. I hate to call them risky. In some cases, they're

• 16:15Ryan Sean Adams?

  very risky, but like definitely volatile, right? They could lose 80% at the snap of your fingers. You never know. I got to assume a Silicon Valley bank is not going and buying like DeFi tokens and, you know, going levered long. They have to have much less risky investments here that are like similar to dollars, much more similar dollars to dollars than a volatile crypto asset. Can you tell us about that side? Because that does seem like it's different, it should be different in the US banking system versus a Celsius or a BlockFi wager.

• 16:48Speaker 02

  That's absolutely right. So let me talk about what banks generally loan to or invest in, and then SVB, because SVB is a very unique animal. So, community banks, and there are about 4,000 plus of them, generally loan against commercial real estate. And that could also be financing commercial industrial loans or construction loans. And that's the bulk of loans for a community bank. Now you have these mega center banks and these other regional banks that also offer credit cards. So they take those deposits and they finance credit cards or auto loans, historically in the past, student loans. And banks will also finance mortgages. Now generally, banks will make a mortgage and then sell it to Fannie Mae and Freddie Mac,

• 17:31Speaker 02

  but to the extent that, for example, First Republic makes mortgages that Fannie and Freddie will not buy, and they'll just fund that with their deposits. So that's what they do. And in general, you'll notice that banks finance real assets that have cash flow. If you're financing a mortgage, you've got a collateral. It's called a house. If you're financing an auto loan, you've got collateral. It's called a car. Citizens Finances, Apple cell phones. And if you're financing a student loan, there's human capital behind it generating cash flow. So banks are conservative. In fact, the average return on an asset for a bank is around 2%. Silicon Valley Bank is a bit different. Silicon Valley Bank not only had primarily commercial depositors and 90% of those deposits were uninsured because of that concentration.

• 18:15Speaker 02

  They also did venture debt.

• 18:17David Hoffman?

  Uninsured, sorry, Ron, by FDIC uninsured because they're above the 250K limit.

• 18:22Speaker 02

  You got it. Exactly. FDIC uninsured. And they had two types of lending programs in a venture debt financing, and they also provided credit facilities to VC funds. I'll explain that briefly. So in venture debt, let's say you do a Series A round and you need some additional capital. You want to do a quick bridge. Silicon Valley Bank could underwrite you and give you a loan. They might take some warrants for that. And Silicon Valley Bank gives you cash flow and you pay back Silicon Valley Bank in the next round. It's a very unique business Silicon Valley Bank does. No other major bank does that, much less a community bank. The other bank, the other product they had, of course, is financing venture firms. So for example,

• 19:06Speaker 02

  a venture firm might have a hot deal. It takes three weeks to do a capital call. They want to provide an investment now, so they'll borrow from Silicon Valley Bank. That's called a credit facility.

• 19:18David Hoffman?

  And so we're starting to, what it sounds like, mix the world of banking with the world of venture and in just normal financial services applied to these various different venture firms. But just at a high level, like spinal reflex response, banking and venture seems to go hand in hand a little bit less, just by in nature of the risk that the venture industry does have. Is that, is that a fair intuition, Ron?

• 19:45Speaker 02

  Banks have an important role to provide bank accounts and enable payments to businesses. I mean, banks are the business of payments, lending and custody. That's what a bank is. So, you know, making venture debt loans, like the jury's out. There's a reason other banks don't do that. And Silicon Valley Bank had an, had an edge in that business. And that edge was the implicit backing of Silicon Valley to refinance or have a new equity around so that they wouldn't actually have loss. This is one of the reasons I believe that you haven't seen a major bank acquire Silicon Valley Bank. Because if that venture debt portfolio of $70 billion.

• 20:25Speaker 02

  And they're going to experience defaults as we go through a cycle, then they don't want to be stuck holding the bag.

• 20:33Ryan Sean Adams?

  Right. So Silicon Valley Bank specifically engaged in banking and financial services for a particular industry because it had edge, as you said, that made that activity probably less risky than other banks, but other banks are still won't touch it just because it's new and novel and potentially more risky because they don't have that edge. Is that a fair summary?

• 20:52Speaker 02

  It's risky, right? So, so what Silicon Valley Bank was doing was making loans to unprofitable tech companies. That's what it is. So when you're taking a loan is a, you're taking credit risk. You expect to get paid back more than the equity shareholder. If you take a, make a loan to an unprofitable company, arguably, you're actually taking equity risk. And now, you know, we had 14 years of QE, we had valuations, we had easy money, it was easy to refinance and the risk was low. And it was a great growth engine for Silicon Valley Bank. But of course, in addition to that, Silicon Valley Bank had egregious investments they did with long duration treasuries, we can get into that, which led to their demise.

• 21:33Ryan Sean Adams?

  Okay, so they have a different portfolio of assets that are protecting the deposits in Silicon Valley Bank than almost any other bank. And those are skewed towards like credits, towards these kind of startups and VC firms. I'm wondering, Ram, if you could kind of explain this to us. So this is a tweet. You said, one of these banks is not like the other. And then you're showing this chart of impact of unrealized securities losses on capital ratio. And apologies for the podcast listener, but there's a visual here that if you want to catch that, you got to tune into YouTube for this particular part. But what we're seeing here is SIVB, which is Silicon Valley Bank, I imagine. It's like kind of an outlier dot. You see all of the-

• 22:17David Hoffman?

  Not by a little bit. It's a lot.

• 22:19Ryan Sean Adams?

  By a lot. You see all of the other banks and they're kind of like, you know, up to the, I guess, six to 14% range. You know, the trend line looks like it's between like eight and 13% or something like this. And then you have this outlier bank. So what is this chart showing us?

• 22:37Speaker 02

  So what this is saying is that Silvergate effectively had no equity.

• 22:42Ryan Sean Adams?

  Oh, this is Silvergate. This is not Silicon Valley Bank. Okay, this is Silicon Valley.

• 22:46Speaker 02

  Correct. So what, so banks by law are required to hold capital. So what is a bank? A bank's got about 10% on average of what's called tier one capital. That's the equity of the bank. And then 90% of the balance sheet is financing primarily from depositors. And in general, those depositors are insured by the FDIC. So you can see why government actually has a key risk on banks and they supervise and regulate banks. So we talked about the lending side of Silicon Valley Bank. Those are those illiquid loans, but Silicon Valley Bank and other banks also have a securities portfolio. And by regulation, these securities portfolio consist of what's called HQLA, high quality liquid assets.

• 23:29Speaker 02

  Those are generally treasuries and mortgages. So what this is saying is that if you mark to market the treasuries and mortgages on the balance sheet for Silicon Valley Bank, that Silicon Valley Bank has zero equity.

• 23:44Ryan Sean Adams?

  What? How? So how is that possible? That's because the mark to market of the securities that they purchased is just a lot lower than the par value of them?

• 23:57Speaker 02

  Right, versus the purchase price of the bond, right? So in Q4 21, now this is peak crypto. This is peak venture funding, record funds raised. Silicon Valley Bank had record inflows of deposits, like tens of billions of dollars record inflows. And in a short interval of time, what they did is they bought the longest duration treasury bonds. And duration is when you expect, the average time you expect to receive a cash flow. So the longer the duration, the more interest rate risk you have. So this is before the Fed started raising rates, although the Fed was talking about raising rates then, and inflation was going up.

• 24:40Ryan Sean Adams?

  So this is what, that seems dumb because they were essentially betting that the Fed wouldn't raise rates.

• 24:48Speaker 02

  I don't know that they were conscious. It was, it's, in my view, it's a gro- it was grossly negligent. Uh, they took tens of billions of deposits and they bought long duration treasuries. Now, what happened last year? Of course, we saw sixty forty didn't work, right? The stock had probably to work. Well, the forty is bonds. Those bonds were down twenty percent. And here's what happened. So here's one way to think about a bank that people don't appreciate. I mentioned earlier, if you look at the bank's capital stock, meaning the bank is financing assets with a mix of liabilities, deposits and equity. That equity component's about ten percent. It borrows ninety percent through deposits. That means on average, your bank has ten turns of leverage.

• 25:28Speaker 02

  A bank is borrowing short, they're lending long, they have ten turns of leverage. So now your securities portfolio goes down twenty percent. Imagine you've got fifty billion dollars in securities. And now that fifty billion dollars portfolio is worth forty five billion dollars. You've lost five billion dollars, but now you've got ten turns of leverage. That is why you have this unrealized loss in the securities portfolio. By the way, this was known by regulators. Regulators have talked about the issues in the HTM portfolio for some time. In fact, the Federal Reserve has about a one point five trillion dollar unrealized uh, hold to maturity loss. The difference is that the Federal Reserve can hold to maturity and the regulators hope

• 26:10Speaker 02

  that these other banks can hold to maturity, in which case they'll actually make money on the bond.

• 26:14Ryan Sean Adams?

  And I just want to clarify for, for people who you said, um, bonds fell twenty percent in twenty twenty two. Bonds aren't, bonds aren't supposed to fall twenty percent, right?

• 26:25Speaker 02

  That's correct.

• 26:26Ryan Sean Adams?

  Unexpected. I mean, for the crypto listener, they'll be like, just twenty percent? That sounds fantastic. Sign me up. But that, this is supposed to be a

• 26:34David Hoffman?

  The foundation of the entire global financial system.

• 26:37Ryan Sean Adams?

  Yeah, it's an important asset to not fall. And it was, uh, obviously a core asset that Silicon Valley Bank was, was betting would not fall by anything close to twenty percent.

• 26:47Speaker 02

  You, you nailed it. So, so bonds prices drop when rates go up. They're the same thing, right? So we had fourteen years of ultra-low interest rates. We had the Federal Reserve buy about nine trillion dollars in treasuries and mortgage-backed securities. Twenty five trillion dollars in quantitative easing globally. Other central banks, in fact, had negative interest rates. Think about the banks that bought those negative yielding bonds and holding maturity for a loss. So that's the backdrop. And then we saw inflation increase. Of course, that was partially driven by two trillion dollars in COVID stimulus, which is multiples of what we've ever seen in any other recovery package. So yet inflation and now rates are going up at the fastest rate since nineteen eighty one.

• 27:30Speaker 02

  And there is a new regime and that regime is called higher real rates, which is what, as you mentioned, Jim Bianco has talked about.

• 27:38David Hoffman?

  Yeah, so we we often talk about this idea of going further out on the risk curve. And that's actually a really easy thing to visualize when we talk about bonds and bonds yields. And what you said, the longest term maturity bond bond yields. I can't remember the actual specific name of the correct asset, but just like they are buying the longest dated bonds possible. SVB is Silicon Valley Bank is because that's where they get the most return in interest rates. But they also take what you said is the highest interest rate risk because they are so far on the risk curve. But that's what you must do in an era of zero interest rates in order to have any margins whatsoever.

• 28:20David Hoffman?

  And so one part of this equation is like, I think everyone agrees Silicon Valley Bank totally mismanaged their risk. And also, we also had the fastest interest rate hikes in history or in in my lifetime. And so these two things have collided. And and so that's really what I think we're seeing here on this chart. And, Rum, I want to check my understanding of this chart. We we're seeing two different lines here. One is a line of blue dots and one is a line of yellow dots that are scattered and below the blue, the blue line. And the the blue line is is titled common equity tier one capital ratio. I don't really know what that means. My gut is that this is what it would have been like if the interest rates hadn't been yoked to infinity really, really quickly, to be hyperbolic.

• 29:04David Hoffman?

  And so all of these bank, all of the yellow dots, all of the bank, the banks, individual banks, you see JP Morgan. There you see Bank of America, etc. You also see Silver, God, Silicon Valley Bank at the very, very bottom. The gap between these two lines, am I correct in my understanding that that is the interest rate hikes? Like that is, and so people who are further down, fallen down are people that have taken further risk than other banks that haven't taken as much risk. Am I interpreting this?

• 29:32Speaker 02

  That's exactly right. You nailed it.

• 29:34David Hoffman?

  Cool. Okay. So again, so now we've pinned, I want to re like, go through other conversations so far. Mobile banking and, and time to withdraw is the fastest it's ever been. Finance is moving fastest ever been. So bank runs are more susceptible regardless of conditions. Then we had this one bank, Silicon Valley Bank, that serviced a higher risk end of the spectrum in terms of financial services, which was the venture world. And then also it happened to just take more risk itself, being inside of that milieu that it was. And then also, interest rates got, got jacked up faster than it's ever been before. So these are the, these are the big parts of this multivariate story. I don't think we're done yet. Rom, where should we go from here?

• 30:20Speaker 02

  Well, let's zoom out for a moment. What you're seeing is the unwind of carry trades. Let me define what a carry trade is. So a carry trade is when you borrow short in a currency. It used to be the Japanese yen, low interest rate economy, economy. And then you make a loan in a higher interest rate economy and you capture that spread. And that hedge fund strategy works so long as the policy rate environment is stable. So in this period of ultra low interest rates, all sorts of carry trades were created. One of them was the great scale Bitcoin trust trade, which you guys have talked about in your show. Another is in the convenience of brokerage account, you could have borrowed and bought muni bonds. You could have levered muni bonds and get a nice equity like return.

• 31:03Speaker 02

  And that's also taken place across these non-banks that have had issues. And that's what's happening now. So think about Silvergate, for example. Silvergate in a way is a carry trade. It's not a critique of their business model. They're responding to incentives. They paid out zero percent to their depositors and they're earning that spread. And that game works in a zero interest rate world. But what happens is when you raise rates and you have an inverted yield curve, the incentives change. So remember, we talked about before, what banks are doing is they're borrowing short and lending long. The expectation is that they borrow at a very low interest rate. J P Morgan today is still borrowing around zero percent in deposits. And they lend long and there's an expectation that that yield curve is positive and they make that spread.

• 31:49Speaker 02

  Now this yield

• 31:49David Hoffman?

  I just really wanna for, once upon a time, I remember when I did not understand a yield curve. What this really means is a yield curve means is that as you take more, that as you go further out on the time, go from two-year maturity to 10-year maturity, you get paid more. That is the normal course of events. An inverted yield curve is actually when you are paid to take less time. And so the two-year treasury pays you more than the 10-year treasury. I just wanted to like place that the on the ground there.

• 32:17Speaker 02

  That's right. Exactly. So the yield curve is a, it's a plot of the duration or time axis and then the yield. So for example, the 10-year bond is at 3.6 right now and the Fed is expected to raise rates to call it 5%. So now what are the motivations and incentives? So first off, if you're a bank, why would you lend long? If you can just lend in short duration treasury securities and take zero risk? Or are you taking the risk on the federal government less inflation? So you're starting to see that happen. Uh, and that also, you know, that's what drives the slowdown in the economy, of course, right? So credit card rates, auto rates go up and that starts to lower the band. But there's a, there's a challenge that's happening here because as the Fed raises rates,

• 33:01Speaker 02

  uh, what's happening is it's creating a 600, 700 billion dollar hold to maturity unrealized loss across the banking sector. Because those banks are now underwater. So the more the Fed raises rates, the more the banks have these unrealized losses on their balance sheet.

• 33:20Speaker 02

  And also, the Federal Reserve has losses on their balance sheet and the Federal Reserve will continue to pay out more than it brings in. We can come back to that later. But here's the other side. Here's the other challenge. So the capital markets, meaning like money markets as a product, are paying out more than the deposit than the yield you get from your local bank. So if, for example, you buy Vanguard Money Market Fund, we're helping Protocol Treasurys do this now, right? They're saying, hey, how do I get yield? We put them in an ultra-short duration bond fund that pays off four and a half to six and a half percent. So why would you park your money at a bank? Again, these banks, they don't offer that kind of yield. And for them to hold on to deposits, they have to raise their interest rate.

• 34:05Speaker 02

  But now, what happens? Now, recall, the average return on assets is around 2% for a bank, maybe 3%, okay? So if they raise the deposit payout, they're gonna, they're not capturing as much spread. And they can't really raise it above 2% to 3%. And it can't really compete with a money market fund. So this is why if you look at Signature Bank, over the last year, we saw about $20 billion in withdrawals from Signature Bank. It's kind of, it's not a bank run, but it's a slow-moving bank run. Because commercial businesses are responding to incentives. And arguably, you could say Silvergate was subject to that.

• 34:47Speaker 02

  And to some extent, SVB as well. But that's true for other banks in the land as well. So in some sense, the Fed is like in this checkmate position, where if they raise rates, things go bump in the night. We see those lagged effects. They lower rate, they get inflation, and that's the conundrum we're in.

• 35:06Ryan Sean Adams?

  And really quick, Ron, a money market is not the banking system. That is sort of a separate ETF. It's like a separate pool of capital that is basically competing against bank deposits. So the question of why would you keep money in your Wells Fargo account, right? When it's giving you like 1% interest versus putting it in a money market ETF in Vanguard, which is giving you 3%, right? All the capital is going to flow to the 3% money market, which is a different pool, and out of the banks, which kind of causes the slow-motion bank run. Is that right?

• 35:38Speaker 02

  That's what's happening now. There's a chart in the document that shows there's about like a high-single-digit drawdown in deposits in the banking system. So right now it's mostly corporate treasures that are conducting that behavior change, although the headlines from the last week created awareness in households across consumers. It created also some urgency and some panic, maybe. And that's causing them to shift their portfolio, but it's still early days.

• 36:06Ryan Sean Adams?

  Is this, is this the graph?

• 36:07Speaker 02

  Uh, no, it's another, it's another chart. Um, uh, yeah, scroll down, let's see there.

• 36:14Speaker 02

  Uh, no, it's not there. I can send it to you. I can send it to you later.

• 36:17Ryan Sean Adams?

  Okay.

• 36:18Speaker 02

  But yeah, so real quick, like, and why this, this has like policy implications to an economic implication. So what's a money market? Let me define that real briefly. So a money market consists of investment grade bonds that are just about to mature and pay off their last payment principal. Right? So those bond insurers of those companies can access the capital markets. Google, Apple, IBM, Ford Motor Company. There you go, that chart. So look at February 22, you can see, sorry, there you go, uh, about, uh, two and a half percent, sorry, drawdown from the bank deposits at peak. Right? So that.

• 36:51Ryan Sean Adams?

  Wait, wait, so what is this chart here? This is, this is cash getting withdrawn.

• 36:55David Hoffman?

  Stablecoin outflows out of crypto exchanges, Ryan? This is like the trad version of this where.

• 37:01Speaker 02

  You nailed it.

• 37:01David Hoffman?

  Yeah. So this is a stablecoin, AKA dollar outflows out of banks and into money market funds, which is kind of like investing in, in the spread of compound or something like this. Is that, is this a fair?

• 37:14Ryan Sean Adams?

  Oh, yeah, that's, my God, banking is making sense to me now that I understand it in terms.

• 37:20Speaker 02

  Just like, just like higher rates withdrew funds from DeFi because people want to get the T-bills now. It's the exact same thing. You nailed it.

• 37:27Ryan Sean Adams?

  Is this what TradFi feel like, by the way, when they're trying to understand crypto? They have to go the opposite direction?

• 37:32Speaker 02

  Yeah, it's pretty similar, actually. There are a lot, there are a lot of, what, what is crypto? It's payments, it's lending, it's settlement, it's custody, and that's what banks do.

• 37:40Ryan Sean Adams?

  Okay, so this chart is super interesting because we can see this big spike down in February of 2022.

• 37:47David Hoffman?

  We haven't seen a spike this large since 1981.

• 37:51Ryan Sean Adams?

  Which, that was a bad year, right?

• 37:54Speaker 02

  Well, you're right. That was, that's when you had record rate increases by Paul Volcker.

• 37:57Ryan Sean Adams?

  Ah.

• 37:58Speaker 02

  And of course, uh, you had a bear market. It ended the year following, and that set in motion a 40-year bull run in equities as well. So yeah, we're, we're, uh, we're doing a kind of a playbook there from, from 81.

• 38:11David Hoffman?

  Okay, is it okay if I put this Google Doc in the YouTube chat?

• 38:14Speaker 02

  Yeah, go for it.

• 38:15Ryan Sean Adams?

  This is another question I have for you, Ram. So, okay. So you you mentioned that the problem is this carry trade. And you explained the carry trade. And you say that meta-pattern is the reason Silvergate died. It just happened earlier because it was involved in this super risky category of assets called crypto. And you saw basically the carry trade playing out in GBT and Bitcoin spot price. And that was that. And then the symptom of that eventually, like dominos are falling. And then the Silvergate domino fell. But it's the same Fed raising rates, carry trade type problem. And now the dominos have collapsed. And now we're in Silicon Valley Bank. My question to you is-

• 38:58David Hoffman?

  The virus has gotten to TradFi now.

• 39:00Ryan Sean Adams?

  Right. So like, so like, I feel like maybe it's a meme of like, bankless, not bankless, but everyone's saying, maybe bankless too, David, to be honest. Like, oh, that was the last domino to fall. It's good. We're good. And like, we said that at the end of last year, it's like FTX. And okay, if we only get through this DGC thing, then that's the last domino to fall. But now the dominos have, and maybe it was in crypto. Maybe that was the last domino to fall in crypto. Now the dominos are falling into the banking sector and the traditional finance world. And we had Silvergate. And then very shortly after, just days later, we have Silicon Valley Bank. The same symptom. It's the carry trade problem. What's next? Who else has the carry trade problem?

• 39:42Speaker 02

  It's a great, it's a great question. So yeah, first off, the positive yield curve motivates credit creation and it creates leverage. And that boosts asset prices. That's the simplest way to think about it. 14 years of that, and people are equilibrated to these low rates. They conditioned their behaviors, human psychology around that, and they planned around that. Now inverted yield curve, and that leads to credit destruction because people pull in. Banks are slowing down the pace of lending, for example. Now- Here's, here's what's gonna happen in TradFi. It really will turn on policy and there are two policies you gotta look at. What is gonna happen with monetary policy and the behavior of the Federal Reserve? They have to make a choice. Do they want to stamp out inflation? At the risk of creating more risks?

• 40:27Speaker 02

  Um, or do they want to reflate the banking system? Uh, by lowering interest rates and of course now markets starting to price a lowering of interest rates. That's one policy. The other policy is what will the bank regulators do for other regional banks that uh apparently have liquidity? Issues. Will they intervene to protect depositors? Those are the two things to watch to understand what happens from here.

• 40:55Ryan Sean Adams?

  So, but Ron, okay, here, here's why I want to understand it. So we've, we've been in crypto since the early days. Uh, like of, of this kind of crisis, right? This yield curve, curve inversion and the carry trade collapsing. We've seen all the dominos fall. We've been tracking it up to here. Now the dominos have fallen. Wasn't the action on Sunday? The Fed actually putting its foot down? Imagine this row of dominos falling in. It, it basically ends the, the, the endpoint is the end of all finances we know it, like the world is burning at like. The rest of the dominos. Yeah, it's Armageddon. It's like terrible, right? Um, but didn't the, the, I'm saying the Fed, but I don't mean the Fed. Didn't um, basically the US government, Treasury, the Fed collectively, just on Sunday, put their foot down?

• 41:41Ryan Sean Adams?

  In top of the dominos, send some domino scattering, but they put their foot down in the middle of the, the sequence of dominos falling and say, this stops here. And they said basically Silicon Valley Bank? Equities wiped out. But depositors are secured. Signature Bank? Equities wiped out. But depositors secured. This contagion is not spreading any further and therefore it can't spread. It can't get through. You know, Jerome Powell and Janet Yellen's foot, because they have their, their, their foot placed on the, on the, um, the row of dominos here. Is that effectively what happens? Like have they stamped it out?

• 42:15Speaker 02

  That's the, that's their goal. That's what they want to happen. They did, as you pointed out, they insured all uninsured. They're gonna make sure all uninsured depositors are made whole. Uh, what they did not do is provide a system-wide guarantee to deposits. Well, they cannot, right? So the FDIC, in terms of their authority, it's beyond their limits. By the way, the FDIC has $125 billion in their insurance fund and there's $20 trillion in deposits. So it would take an act of Congress to put a system-wide guarantee. That said, they did roll out a program to create confidence. So I think in broad brushstrokes, you're right. That's their goal. They're saying to the public, hey, banks are safe. Work with banks. And I believe they will do everything they can to stop a bank run.

• 42:57Ryan Sean Adams?

  Okay, so I, so the, the letter of the law for FDIC is if you have a deposit at the bank, it's only insured up to 250K and above that it's non-insured. What they basically said is for Silicon Valley Bank and for Signature Bank, we are breaking that rule and we are insuring all depositors up to infinity.

• 43:20Speaker 02

  Yes, yes.

• 43:20Ryan Sean Adams?

  My impression is like de facto, they're signaling to the rest of the entire banking system that we will insure your deposits up to an unlimited amount. But you're saying maybe they implied that, but they actually don't have the power to grant that ability because that requires an act of Congress and you actually have to go vote on something and change laws.

• 43:44Speaker 02

  I think you got it right. And look, I'm betting that's correct. I think everything you said there is correct. And I'm betting on that. I think I bought financials, you know, yesterday, for example. I'm betting that the regulators will do what they can to safeguard the public's confidence in the banking system and stamp out runs. Right? So overall, in broad brushstrokes, you're correct. That said, they haven't issued a system-wide guarantee, which is what Bill Ackman has been arguing for and keeps arguing for.

• 44:09Ryan Sean Adams?

  But they don't need to. If they're, if they're, I guess, if they can stop it here, they can just say the signal that we're prepared to do this is the signal of the market. And as long as that stops bank runs, they'll never need to actually get to the point to put a new law in place and increase FDIC's mandate.

• 44:25Speaker 02

  That's right. They're trying to stamp out the fire before it becomes a forest fire. And by the way, no taxpayer funds put to work. The FDIC fees are assessed against the banks. The banks will pay for this, which is great. However, here's the other thing, and this is outside the control of the FDIC, which is, it goes back to the other issue about higher interest rates.

• 44:49Speaker 02

  If you continue to see a movement from banks to money markets, not because of fear of banks, because consumers are responding to incentives, then it doesn't matter if you've got a system-wide guarantee.

• 45:04Ryan Sean Adams?

  Ah, so if the money market trade continues to exist, that may not stop the forest fire.

• 45:11Speaker 02

  That's correct. There's a slow burning, right? Go back to like Signature, they've had a $20 billion year-over-year decline in their deposit, which is about 20%. This, this flow that we have to see, does it accelerate or not? Now, I don't think consumers, retail households by and large, had much behavior change. We know that because JP Morgan's deposits are still growing and they're paying out 0%. But the commercial treasurers have started to adjust. And last weekend was a wake-up moment for the household, for some households that read periodicals like, like what we do, more forward-looking. And they're saying, gee, inflation's at 5%, I'm earning 1%,

• 45:55Speaker 02

  why don't I get a Vanguard money market fund? If that happens, what are you gonna do? System guarantee is not gonna help that money movement.

• 46:02Ryan Sean Adams?

  So that's not quite a bank run, but you're, that's what you're calling is a slow-motion withdrawal that's happening just because there's this arbitrage opportunity, basically. And I guess, how does the, how does the banking system yell in and powell stop that?

• 46:20Speaker 02

  It's hard. It's very, very, the way you stop it is you lower interest rates. The Federal Reserve lowers interest rates. This is the, this is the conundrum.

• 46:28Ryan Sean Adams?

  But then how do we fight inflation?

• 46:30Speaker 02

  Exactly. Exactly. And this is the, you got it, this is the aha moment. Now, what can a bank do to stop deposit flight? They can raise interest rates to create an incentive to keep your money market funds, but it's not mathematically possible for a bank to offer a 4.5% interest rate. They would be unprofitable. And so that would impair their equity. So one way or another, you, you can see how the banks are in a bad position. If rates go up, that hold-to-maturity portfolio declines in value. If Federal Reserve raises rates, the whole maturity portfolio declines in value. If they raise rates, they lose money. Silvergate went through this as well. They issued CDs that they're paying money out and they have to pay an interest rate on that. They're going to lose money on that.

• 47:14Ryan Sean Adams?

  I want to ask about one last thing and then I know, I know we want to get to sponsors and we've got a lot more to cover though. You said something that, that perked my ears, which is taxpayers aren't responsible for this, right? Or they, this is not going to cost taxpayer money, I think was the, the word you used. That's also what I saw in kind of, you know, Biden's tweet outs and that sort of thing is not going to cost. But didn't they do something else? Didn't they also effectively say that long dated treasuries would not be mark to market value for banks, but would be par value? Didn't, wasn't there some move of treasury to sort of, or whomever's responsible for this?

• 47:57Ryan Sean Adams?

  Kind of reset the value of this collateral on the banking balance sheet? And isn't that in net effect, not a direct tax on taxpayers, but a tax by way of money printing, by way of quantitative easing, by way of supply issuance, seniorage, whatever we want to call it. Isn't that in effect a tax, a sneak attacks on, on taxpayers? Or at least kind of money supply inflationary pressure?

• 48:28Speaker 02

  Well, it's, it's really, I, I look at it differently. I mean, the existing laws of the land already in terms of banks, how banks account is allows for whole to maturity accounting. Right? So banks can hold a bond at cost. And that's what SVB did. That's what all the banks are doing, but it's all disclosed to the public. So if you go to the, the 10Q or the 10K of a bank, you can see what the unrealized losses on that bond portfolio. You can do the math and ask yourself if they were, if they had a bank run, which would force them to liquidate, which of course will happen with Silvergate. Then you can calculate what that loss would be to the bank holder equity. Uh, so that's existing law of the land. I did not see any change around that. You could send me a link. I can take a look at that.

• 49:14Speaker 02

  The regulators did introduce a new program. It's called the BTFR program. Essentially, it's like a, a fund uh, that's meant to um, you know, step in uh, to help the banking system. And again, the, the fees for that fund are assessed against the banks.

• 49:31David Hoffman?

  Rum, I just want to check my understanding. You, you, you said that it's simply just like not profitable for banks to be offering sufficiently high yield to maintain deposits. Is that what? And I'm going to show her on my screen here. Uh, this is a tweet that we, uh, shared out yesterday. This is already 24 hour old data, so I don't know what the banking sector did today. But to me, this is, this is that being reflected in the market where the smaller and smaller banks are getting hit with a repricing event. Because the market has understood that the long tail of banks, and here's my question to you, is that like the 0% interest rate paradigm? Has created a long tail of banks. It's allowed for banks to exist, many, many more banks to exist because they never had to pay out interest rates.

• 50:15David Hoffman?

  They had no costs for deposits. And so now I think perhaps what is happening here is when we talk about a phase change in the market. The long tail of banks are being made unprofitable. And is that what is being reflected in the market?

• 50:28Speaker 02

  Well, if the, the, the banks are still making money. Uh, the banks, they can hang on to deposits if they raise interest rates. But increasingly savvy depositors starting to migrate to money markets.

• 50:42David Hoffman?

  Right.

• 50:42Speaker 02

  So if that, if that accelerates, then the banks have an issue because they cannot compete with the money market fund. They'll have to raise rates. So far, the banks are making money, to be clear. Uh, but there's this issue where the more the Fed raises rates, the more incentive there is to shift out of your depository institution into a money market.

• 51:02David Hoffman?

  Hmm. Why do we have money markets in the first? Like, couldn't you just like delete money markets entirely and then have some sort of a central bank digital currency and like? Provide um, everybody who is a holder of US dollars digitally, some sort of return directly from, from treasury?

• 51:21Speaker 02

  Well, so treasuries are part of the money market. Corporate bonds, investment-grade bonds, you know, asset-backed securities. These are all part of the money market. Money markets, the collection of bonds that are about to mature. So when you say, why do we have money markets? It's like saying, why do we have capital markets? And capital markets play an incredibly important role in driving capital formation, right? Those equity capital markets, think about it as an IPO. But they're also initial debt offerings. Those initial debt offerings create the bonds that eventually work their way into the money.

• 51:50Ryan Sean Adams?

  Maybe I mean more, why do we need, um, why, why do we need banks as a middleman to?

• 51:57Speaker 02

  Good question, good question.

• 51:58Ryan Sean Adams?

  Depositors funds is probably more what I mean. Why do we need banks?

• 52:03Speaker 02

  Apropos question, apropos question from a bankless co-host. And I never would have guessed, we're going bankless by taking three banks out in a week. Here's why. So the capital markets are open to large institutions, right? In S1 filings, when you go public, in IPO, it's an incredibly high standard. We cannot access, the three of us cannot access the capital markets. Apple, Google, Microsoft, tech overlords can access the capital markets. So where does mom and pop, or Joe Sixpack, or the farmer access funding? They get it from their banks. And by the way, the top five banks, including JP Morgan, Bank of America, they're on the coasts. So you're talking like middle America and rural America.

• 52:43Speaker 02

  And the population's not benefited from the growth and asset price inflation. It's that population. So banks play an important role in extending credit. And by the way, bank loans are cheaper than equity cost of capital. They're the cheapest source of funding, in fact, in the land. And so they play a very important role. You know, if you want to look at a world without banks, there's a wonderful book by Hernando de Soto called Mystery of Capital. Like David, you're nodding your head, right? And his basic headline is, you know, one is you need property rights and title to property. But the second message is, once you have that, you can liquefy that. So if you, there are people in Egypt, let's say, that have a home.

• 53:27Speaker 02

  They, the convention is they own it, but it's not recognized as such. And they can invest in their home. So you'll see them put a roof on one year. Two years later, they paint the house. You ask them why? Because they can't get a mortgage. Or, you know, a farmer can invest in a plow. They're trying to make an economic decision, but they cannot finance the productive growth at investment because there's not a bank. So instead, what you have are de facto equity markets. Those are called like loan sharks. So banks play an important role in credit intermediation.

• 53:56David Hoffman?

  Right, right. Ram, there's a bunch of other topics that we have to get into that. I want to ask you about what's your opinion on whether or not Silver Signature Bank was targeted? I know we got to talk about the impact on crypto and the impact on USDC. And then we also, I want to get your take on yields and interest rates, whether or not this is the pivot moment that we've all been holding our breath for or not. So we're going to get into all of these subjects and more. But first a moment to talk about some of these fantastic sponsors that make the show possible. Uniswap is the largest on-chain marketplace for self-custody digital assets. Uniswap is, of course, a decentralized exchange, but you know this because you've been listening to Bankless.

• 54:37David Hoffman?

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• 55:17David Hoffman?

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• 56:01David Hoffman?

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• 56:45David Hoffman?

  your first-stop shop for every token worth investigating in crypto. Bankless Premium also gets you a 30% discount to the Permissionless Conference, which means it basically just pays for itself. There's also the Airdrop Guide to make sure you don't miss a drop in 2023. But really, the best part about Bankless Premium is hanging out with me, Ryan, and the rest of the Bankless team in the Inner Circle Discord, only for Premium members. Want the alpha? Check out Ben the Analyst's DGEN pit, where you can ask him questions about the Token Report. Got a question? I've got my own Q&A room for any questions that you might have. At Bankless, we have huge things planned for 2023, including a new website with login with your Ethereum address capabilities, and we're super excited to ship what we are calling Bankless 2.0 Soon TM. So if you want extra help exploring the frontier,

• 57:30David Hoffman?

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• 57:39Ryan Sean Adams?

  Hey guys, we're back with Rom. Man, there are a million ways we could, we could take this next direction. Can we talk maybe first about the story of USDC? So what happened there? Was USDC the stablecoin ever at risk here?

• 57:56David Hoffman?

  And also note that we are talking in 24 hours with Jeremy Allaire.

• 58:00Ryan Sean Adams?

  Oh, we'll ask him the same question.

• 58:03David Hoffman?

  We'll ask him the same questions, yeah.

• 58:05Speaker 02

  Well, as you know, replay last week, so USDC broke the peg, traded down as low as 88 cents on the dollar on reporting that 3 billion plus of the USDC reserves outstanding were held at SVB. Then on Sunday, the FDIC announced an action to make uninsured depositors whole. USDC closed the peg, I think it's like 99.9 cents on the dollar, it's there effectively. And Circle has shifted their banking relationships to BNY Mellon, which where the deposits are, and they shifted their fiat ramp to Cross River, that was my old shop, I built the crypto business there. So the biggest irony of this whole thing is that USDC is now custodied as, at a systematically

• 58:50Speaker 02

  important financial institution, it's called the CFI. USDC is too big to fail.

• 58:57David Hoffman?

  USDC is held in a institution that is branded, known to be too big to fail.

• 59:03Speaker 02

  It's designated by the regulator as a G-SIP. BNY Mellon not going to go anywhere. So USDC, one of our guys cracked the code, they're in the Emerald City, they co-opted the defenses of the banking system. So USDC is ensconced behind BNY Mellon and we're protected from bank runs.

• 59:21David Hoffman?

  So basically, we got someone inside, on the inside.

• 59:25Speaker 02

  We did it, the Ewoks took over Endor.

• 59:28Ryan Sean Adams?

  So, so USDC only fails if the US banking system fails, basically?

• 59:33Speaker 02

  Exactly, that's right, that's right.

• 59:35Ryan Sean Adams?

  And, and that relationship is hard to get, and we, like, USDC had to go through these smaller banks, like Silvergate first and Signature, and, and now somehow, like, how were they able to get this big, too, too big to fail type banking relationship?

• 59:51Speaker 02

  Well, Germany can elaborate more, but they had a prior relationship with BNY Mellon and Circle has a number of banking relationships. They have five to seven. They try to diversify across that, but the principal institution is BNY Mellon. And you're right, you had to start somewhere. Silvergate was the pioneer and then other banks like Signature got in there as well. And so, but now those deposits are at a G sub institution.

• 1:00:17Ryan Sean Adams?

  So were we happy about this? We're happy about this, right? I don't know. How, tell me how I should feel about this.

• 1:00:23Speaker 02

  It's, it's, I'm trying, I have, my mind is blown. I'm trying to process this myself. It is, look, we need a, we need a centralized stablecoin and a decentralized stablecoin is one take.

• 1:00:36Speaker 02

  Censorship resistance on the one hand, regulated C5, but make it bulletproof on the other.

• 1:00:41Ryan Sean Adams?

  And USDC was never going to be the decentralized one. We know this.

• 1:00:44Speaker 02

  Correct, correct. And arguably, USDC is the first CDBC, maybe.

• 1:00:49Ryan Sean Adams?

  I totally think it is. I, I, I'm, it's perplexing to me that regulators and those in DC haven't realized this.

• 1:00:56Speaker 02

  I think they're going to connect the dots real quick now. And by the way, you know, the American banking system does rely on private markets. Like Americans as an ethos in terms of banking, I know it may not seem like this in terms of banking regulation, they do lean on private market infrastructure. The idea that USDC is our first CDBC is not a, it's not a crazy idea. In fact, JP Morgan has a stablecoin called JPM Coin as well. And in the 19th century, before the creation of, you know, certain banking regulation, I was passed to create the national bank system, you had Wildcat Banks. You had banks issue their own form of, of currency. So it's not a, it's not a crazy idea. It's familiar to the history of the banking system.

• 1:01:36Ryan Sean Adams?

  I am totally waiting for like the Fed to just be like, oh yeah, we're researching a central bank digital currency and like, whatever, we'll do it. And then them basically to co-op, co-opt something like USDC and be like, this is mine now.

• 1:01:51Speaker 02

  I think they could. I think if you were at US Treasury, which is like the policy think tank, the brain for the US government. I believe, I haven't heard this from them, but if at US Treasury, their thesis is probably, hey, we need big mega money center banks like JP Morgan and Citibank to issue these stable coins. I'm not saying that's what they should do. I'm saying that's what I would expect them to have.

• 1:02:13Ryan Sean Adams?

  This event just fast-tracked us towards that, do you think?

• 1:02:16Speaker 02

  Well, yeah, in a certain way it did, it did. And maybe, you know, JP Morgan acquires USDC or Circle, that could be an interesting acquisition to complete the loop.

• 1:02:27Ryan Sean Adams?

  Interesting.

• 1:02:28Speaker 02

  So I'm not saying they will, but that's a logical conclusion, right?

• 1:02:31Ryan Sean Adams?

  And Ram, was, was USDC ever under threat, like over the past weekend?

• 1:02:36Speaker 02

  Well, you know, breaking the buck is one thing, but as you know, there is rumors of Wells notices that SEC Chair Gensler has issued. And, you know, the unknown is, will Gensler consider stable coins on regulated money market funds? And if so, that could put stable coins at risk. So we don't know.

• 1:02:58Ryan Sean Adams?

  Amazing. Because money market funds are securities.

• 1:03:00Speaker 02

  Right. Money market funds are securities.

• 1:03:03David Hoffman?

  Tight, tight, tight, tight. Part of the USDC story is, I'm ignoring that, by the way, I'm moving on.

• 1:03:11Speaker 02

  I'm glad you are. I'm glad you're ignoring that.

• 1:03:13Ryan Sean Adams?

  We'll talk to Hester about that tomorrow.

• 1:03:14David Hoffman?

  Yeah, we'll talk, yeah, that's the agenda. We recorded with Hester first tomorrow, as well as Jeremy earlier. One part of this USDC story, Ram, is this thing called Signet, which was a product out of Signature Bank. I think it stands for Signature Network or something like this. What was it used for? Is it dead? And what should we think about this?

• 1:03:36Speaker 02

  So Signet is still operational. The FDIC is running a global 24 instant settlement crypto network.

• 1:03:43David Hoffman?

  That's what it is. Signet 24/7 settlement for crypto banks or crypto.

• 1:03:47Speaker 02

  Or exchanges and institutions and hedge funds. So it's used to settle transactions. Let me give you an example. Let's say I'm Coinbase, David is Wintermute, and Ryan is Jump. And.

• 1:03:59Ryan Sean Adams?

  Wait, can David be Jump?

• 1:04:01David Hoffman?

  No, no, no, it's too late. You're Jump.

• 1:04:04Speaker 02

  So let's say, uh, I say David is borrowing from Jump, uh, Ryan and, uh, David is at risk of getting a margin call. I send David some funds because I contractually, I'm contractually obligated to deliver that. Um, if you've got a wait time, if you've got like, say T plus three settlement, which is standard in US markets and you cannot make Ryan whole on, let's say your DeFi smart contract, you get margin called even though technically you're solvent. That's called settlement risk. You just didn't get the cash in time to deliver and that's

• 1:04:38David Hoffman?

  Cash is there, it's on the way, but because of T plus one or T plus time, uh, you get liquidated, even though you have all the money, it's just not in the right spots.

• 1:04:47Speaker 02

  Checks in the mail. Exactly. So you need a 24 seven instant settlement layer to match a 24 seven crypto market. Silvergate send played that role. Signet played that role. Without that, it creates settlement risk, operational risk, unforced errors, mistakes for the category.

• 1:05:06David Hoffman?

  This is like a, a shadow Ethereum. Right. A shadow instantaneous payment rail, right?

• 1:05:12Speaker 02

  It's like a layer 0.5 or something like that.

• 1:05:15David Hoffman?

  Sure. Uh, well, it's like its own bank inside of its own ledger, right? So all of these customers have to be customers of the same bank in order to use the service. It's a side chain. Yeah.

• 1:05:25Speaker 02

  That's, that's right. That's right.

• 1:05:26David Hoffman?

  So what, what is, what happened to Signet? Is it now that Signature Bank is gone, where?

• 1:05:33Speaker 02

  So Signature is in receivership. That means management's not in charge. The FDIC runs Signature Bank, has a new name, uh, and Silver Bank, Silver SVB, excuse me, is also being run by the FDIC. Okay. So Signet is still running today.

• 1:05:50David Hoffman?

  So the FDIC is currently running Signet.

• 1:05:53Speaker 02

  That, which is, which is mind blowing again. So, so the federal government has

• 1:05:58David Hoffman?

  We got him.

• 1:06:00Speaker 02

  The federal government has nationalized mission critical crypto infrastructure. I don't think they realize, obviously they were not, that was not their objective. But we need to get a meme talking about how we federalized mission critical crypto infrastructure. We're behind the wall.

• 1:06:17David Hoffman?

  Right.

• 1:06:18Speaker 02

  And it's a Trojan horse, this receivership. But look, here's what's going to happen. The FDIC is going to auction off and attempt to find a buyer in whole for Signature and failing to do that, the auction off the assets and then the liabilities. So the buyer of Signature or their assets will look at the deposit base and say, do I want that depository customer? And if they do, then they have a second question of Signet, of the Signet network. My hope is that they want the depository customer and they maintain Signet. But right now, the federal government is running instant 24/7 crypto network. By the way, this is important to add because there's been so much fud against Silvergate about, and I want to get into that

• 1:07:00Speaker 02

  topic now, we'll get into that later, but around how it's this alleged anti-money laundering network. It's nonsense. If that was the case, the regulators could have shut it down before. They had oversight over Silvergate and allegedly the federal government is running an anti-money laundering network now. Clearly, that's not the case.

• 1:07:17Ryan Sean Adams?

  So Ram, this gets into the question that David was asking before our last break, which is, was Signature targeted? And maybe you could answer that, but the wider context is crypto is like, we're kind of reeling about this because we don't know who our friends in of the government are and who are kind of the enemies, anti-crypto people who just don't want this new financial system at all or are trying to squelch it. And so my worry is like, we're kind of laughing, yeah, FDIC controls now manages a crypto side chain without them knowing it. Ha, ha, ha. But what happens if one of the large banks acquire the Signature thing and acquire Signet along with it? And then the regulators or the anti-crypto government

• 1:08:01Ryan Sean Adams?

  people are like, well, you got to stop doing that. We're going to put an end to that. Let's squelch that. We'll kill it. We're wondering, is crypto being targeted in this? And what do you expect after? There's a lot of rhetoric. I mean, Elizabeth Warren put out an op-ed piece, an opinion piece yesterday and named crypto, you do Ctrl F search, named crypto as being responsible for these bank failures three different times. Is there any concern there? What should we be worried about?

• 1:08:29Speaker 02

  We're going to learn a lot about the regulators' intentions. It gets back to Nick Carter's Operation Troop Point 2.0. So the fact that Signature was put into receivership was a surprise. It was a surprise even for the hedge funds that were short Signature. It is, it's a concern. We need clarity. We will learn over time through FOIA, through investigative journalism.

• 1:08:50Ryan Sean Adams?

  FOIA is Freedom of Information Act.

• 1:08:52Speaker 02

  Correct. I imagine the House Financial Services Committee, led by Chair Patrick McHenry, will also learn more. And I'm sure you may have seen already Senator Frank, who co-authored Dodd-Frank, was on the board. And he said he believes that it may have to do with crypto, but that's his interpretation. We don't know, just to be clear, we really don't know. It was a surprise. You know, there are allegations that there were credit risk issues around Signature. They certainly had a deposit run, which could be caught, which would be cause for receivership. So we really don't know. If Signet keeps running with a new acquirer, then that's evidence that the regulators aren't trying to kill crypto. If Signet is shut down, it's not evidence the regulators are trying to kill it, because it could mean the acquirer doesn't want that business. We won't know.

• 1:09:36Speaker 02

  So we'll have to find out. It does raise a concern. On the other hand, Signet is running today. And it's run by the FDIC.

• 1:09:46Ryan Sean Adams?

  So we don't yet know. TBD. But it could be a, it could be a bad sign about the intentions of the regulators and those in power.

• 1:09:59Ryan Sean Adams?

  Like, we're unclear on why Signature Bank was put into receivership. And it could be a bad sign for crypto if it was targeted because it's a crypto bank and they wanted to knock it out.

• 1:10:10Speaker 02

  And my presumption, yes, my presumption is that it was bank run driven. The regulators have to abide by rule of law as well.

• 1:10:18Ryan Sean Adams?

  Because that would be illegal, doing that. To target a specific bank industry because it services a population, that is not something, that rule of law in the US permits. That is against the law. Right. It's like.

• 1:10:31Speaker 02

  It would be, my interpretation of the law, not a lawyer, not giving legal advice, is that would be a violation of the Administrative Procedures Act, which requires regulators to treat like scenarios likely. Meaning, if you put a bank in receivership, you've got to look at the facts, apply to the law, and say those criteria are met. And the regulators have to hold themselves to account to that. And again, I have a presumption of good faith here. Let's see what happens. Let's learn more. And I we will learn more in the coming weeks and months. My presumption is that it was bank run driven. But I don't know.

• 1:11:04David Hoffman?

  Yeah, I I think we're just we're getting mixed signals on both sides, right? Like if there was true actual risk of contagion, it's actually not that crazy to think that a second bank beyond Silicon Valley Bank was also at risk. That would be actually kind of the indication that you would you would see, right?

• 1:11:21Speaker 02

  Correct. And look, if the regulators really wanted to kill crypto, is there any better moment than post FTX?

• 1:11:27David Hoffman?

  Right.

• 1:11:27Speaker 02

  Right. The Gensler could declare ETH a security, which would be horrible. Coinbase would be forced to delist it. He could declare Coinbase and Kraken an unlicensed securities exchange. Right? And they haven't. So. And this is why we need clarity, interpretive guidance, and we need Congress.

• 1:11:45Ryan Sean Adams?

  We don't know. I just go back to like Barney Frank saying this. That was a direct quote that they're targeting Signature because of crypto. He is no fool. I mean, he knows he knows how the system works inside now.

• 1:11:56David Hoffman?

  And also doesn't care to defend crypto just because it's crypto.

• 1:11:59Ryan Sean Adams?

  I don't. Crypto positive or supportive?

• 1:12:03Speaker 02

  He's on the board. Did he have a privileged point of view? We don't know. My my read of his statement was that it was his interpretation as an observer of the facts. But I don't know.

• 1:12:14Ryan Sean Adams?

  Wow.

• 1:12:16David Hoffman?

  So I want to get into this last topic here, which is interest rates. The market has signaled that this is something breaking and it's time for the Fed to pivot. Yields are down the most that they've ever dropped in since the aftermath of the Black Friday, it says, biggest one day drop in yields for 12 months T-bills since Black Friday, indicating a panic buying of Treasuries. The VIX fear gauge has become elevated. So fear is up, yields are down. The market is saying, hey, this is the Fed's totally not going to continue to raise interest rates. Ram, do you have a stance here? And how do you how should we think about this?

• 1:12:54Speaker 02

  Right. So the Fed has nine days between now and March 23 before they make a decision and they will look at every piece of data between now and then. Obviously, we saw CPI come in. And still, you know, warm. If if not for the recent bank runs, which are deflationary because it caused consumers to pull back and span us and, you know, crouch a bit more. If not for that, you know, would have been twenty five to fifty bips. Right now, markets are pricing in a twenty five dips increase. That's my base case as well. I'd expect that. If you continue to see a waning in public confidence in banks, then that changes.

• 1:13:32Speaker 02

  Like, the only two things that will try drive a Fed pivot are, one, is a significant weakening in the real economy, which is what they're trying to engineer to lower inflation. They're trying to destroy demand. This is what Fed Chair Powell said when he says we're going to have pain in the Jackson Hole summit in August. The second thing that will cause the Fed to pivot is a financial market dislocation. They're very concerned about financial market dislocations. They want markets and the public to be able to rely on their Visa, Mastercard working, their banks to work, the ability to go buy a bond, right? If you recall in COVID, financial market infrastructure broke down. You couldn't buy a muni bond. Credit markets were locked. And that caused the Fed to provide it, you know, credit facility and liquidity to the market.

• 1:14:16Speaker 02

  So my base case twenty five bips, but we got to see what happens from now and then.

• 1:14:19Ryan Sean Adams?

  Yeah, I was gonna say, isn't this financial market dislocation if if?

• 1:14:22Speaker 02

  It's not there yet. It's not there.

• 1:14:24Ryan Sean Adams?

  Because it hasn't hit retail?

• 1:14:26Speaker 02

  Right. So the the failure of these banks is not yet at the level of systemic. That's the view of the regulators. It's also my view, too. These are, these are banks that were indexed to technology and crypto. And, you know, when the tide goes out, those institutions that were the major beneficiaries that liquidated, again, SVB grew their deposits tens and tens of billions. But of course, those deposits went away quickly as well. And obviously, you know, we've seen what's happened. You know, you're seeing the tide go out. You're seeing who's naked, who's over concentrated too much commercial risk exposure. It's not systematic. However, if.

• 1:15:04Speaker 02

  You know, consumers are memetic creatures. We look at others' behavior, we imitate, we follow, etc. If there's a shift in consumer behavior, if consumers start to doubt their banks, I don't think we're there yet. You know, talk to people not in crypto Twitter, ask friends, family, mom, dad, Joe six pack.

• 1:15:20Ryan Sean Adams?

  Yeah.

• 1:15:21Speaker 02

  They're not, they're not there yet. It's not.

• 1:15:23Ryan Sean Adams?

  No.

• 1:15:23Speaker 02

  Magazine.

• 1:15:24Ryan Sean Adams?

  They didn't go through 2022 of like Luna Terra, FTX, like BlockFi, Celsius, and now this. They're, they're not quite there yet. So you're saying that you think Powell and the Fed have some room still to tighten because this hasn't completely broken.

• 1:15:39Speaker 02

  I believe, I believe that they, well, do they have room to tighten? That's another thing. I believe that their base case would be to tighten. That's their own dot plot. Their own projection is to tighten. They are on path to tighten, you know, two or three more times.

• 1:15:53Ryan Sean Adams?

  Got it. But certainly this had to be a shot across the back this weekend.

• 1:15:56Speaker 02

  Oh, yes. Oh, yes. They're going to be.

• 1:15:57Ryan Sean Adams?

  Morning flag.

• 1:15:58Speaker 02

  Every, every day, they're going to be looking at the integrity of the banking system. They're going to look at deposit flows. Uh, and, you know, they, they want an all clear sign for sure. This is, you know, ba- banking crises are extraordinarily deflationary. The Great Depression was not caused by 1929 crash. It was caused by a bank run.

• 1:16:20Ryan Sean Adams?

  Right.

• 1:16:21Speaker 02

  And that's why Ben Bernanke, you know, uh, won a Nobel Prize in Economics and became the Fed chair. It's also why policymakers, you could argue, overreacted to 2008 and slammed the gas with quantitative easing and ultra-low interest rates. So in a way, this is the counter response to the significant deflationary shock of a banking crisis in O A. And the pendulum has come full circle. We're paying the consequences of that now with the central, the, the central bank as well as, um, obviously, you know, the US government debt to GDP ratios at a very high level.

• 1:16:57Ryan Sean Adams?

  Sure. Yeah. So I think what I'm hearing is that we were previously charging into high interest rates and now we are tiptoeing into a little bit higher interest.

• 1:17:07Speaker 02

  That's right. The Fed is, they changed their gear shift from 75 bps to 25 bps. They try to be deliberate, methodical. They're trying to lead markets. There's a question, arguably, markets are now leading the Fed. The Fed was setting pace up till now, meaning markets were expecting a Fed pivot for three quarters in a row. And if you just looked at Chair Powell's prepared remarks, not the Q and A, don't focus on the Q and A, look at the prepared remarks and the transcript. They're very deliberate, every sentence. Now it's changed. We've seen the two year, as you pointed out, dropped substantially yesterday. By the way, we haven't seen these kinds of treasury market movements since like 1987. The tightening and the pace of the tightening

• 1:17:48Speaker 02

  in, of course, that tightening is capital markets tightening, not the Fed. That flight to safety and the 10 year, of course, dropped like 3.6 rapidly. So now the question is, are markets going to lead the Fed going forward? And there's that chicken and egg game. So the Fed so far has been leading the markets and the markets haven't puked when the Fed has continued their rate hike campaign. Will, if the Fed stays the course and the markets are calling for a pivot or expecting a pivot, how does that disappointment translate into risk assets pricing?

• 1:18:26Ryan Sean Adams?

  Ram, this has been fantastic and your, your wealth of knowledge and traditional finance and the banking system has been super helpful for us as we're kind of learning all of this through the lens of crypto, through the lens of DeFi. And that's why, I want to, the last question for you as we, as we close this out is, I know you are as familiar with crypto and DeFi as you are with traditional markets and the banking system. Could DeFi have fixed this? Is crypto the solution to these sorts of problems? How might we, rather than getting blamed for banking crises that weren't precipitated by crypto, how might we paint the case to finance the banking system and treasury

• 1:19:08Ryan Sean Adams?

  and Powell and everyone else that crypto can actually help with these sorts of problems?

• 1:19:13Speaker 02

  There's a positive story here for crypto. The 2008 crisis would not have happened if you settled securities on chain. You'd have the transparency, you'd have the liquidity, you wouldn't have the counterparty risk and you would have had the instant settlement. What does DeFi represent? It represents payments, it represents lending, settlement and custody. So there's an incredible opportunity for crypto to strengthen our banking and financial markets. I wrote an op-ed in the Wall Street Journal in Q4. By the way, with former SEC Chairman Arthur Levitt, fun fact, he was on the board of Bitpay. By the way, first crypto Bitcoin, so not all SEC chairs are credit equal, forward looking guy. And there's, there's an opportunity for crypto, but we need policy to advance.

• 1:19:58Speaker 02

  And we also need to invest in more institutional infrastructure. There's a reason why Genesis existed. DeFi was an institutional grade. And so we need more engineering, more technology, and we need a policy environment as well as a positive vision for crypto. The values for crypto, censorship resistant, lower transaction costs. Those are noble qualities and they improve the quality of life for ordinary people.

• 1:20:25Ryan Sean Adams?

  Ram, are there more of you out there straddling these two worlds?

• 1:20:28Speaker 02

  There, uh, yeah, look, I think there's a big flow of people from TradFi into crypto. TradFi people, uh, look, we, we, we like technology. We were forward looking as well. I promise you, you know, there's, there's quite a few of us out there.

• 1:20:43Ryan Sean Adams?

  That's awesome.

• 1:20:44David Hoffman?

  Tell us a little bit about your company, Lumina, and what you do.

• 1:20:48Speaker 02

  Sure, I'll be brief. Thank you. You know, Lumida is, we're building a web 2.5 private bank. So we believe crypto grows the more interacts the real world as opposed to like a dragon eating its own tail. With DeFi expands and contracts like a cordy, look at like Maker, for instance. So we're building a private bank. We're focused on the top, you know, one, 5% of the crypto market. And we're providing service and investment management. We're helping them manage how to generate yield securely and compliantly

• 1:21:19Speaker 02

  through traditional securities as well. And we're also helping them with alternative investments. The interesting thing about crypto is like the way you made money crypto previously. It's really investing in early stage venture because those venture firms have a structural advantage due to securities laws. Because they can legally participate, whereas you can't do an ICO. So we're building a private bank. We think there's a gap in the market for a trusted institution. We come from crypto. We come from TradFi. You know, my investor base includes regulators like SEC Chair Arthur Levitt, Raj Dhati, former Treasury Advisor, also crypto natives like Mike Dudis and Ryan Selkis. You know, we think that's an opportunity.

• 1:21:59Speaker 02

  We're excited about the promise and potential of crypto and we want to play a role in, in, in, in leading in that area.

• 1:22:05Ryan Sean Adams?

  Well, you are very well positioned and a perfect place to be kind of bridging those two worlds and, and making sense of the banking system for crypto natives and for crypto natives to, to help kind of translate to the other side too. It's, it's great. Rom, thank you so much for joining us today. We appreciate it.

• 1:22:22Speaker 02

  Thanks for having me. Thank you, Ryan. Thank you, David. Be well.

• 1:22:24Ryan Sean Adams?

  Of course, got to end with this bankless nation. None of this has been financial advice. Got to end with our traditional risks and disclaimers, but I'm going to change them up this time. Crypto is risky, but so are banks. All right. You could lose what you put in. You never know. We are headed west. This is a frontier. Um, it's not for everyone, but we're glad you're with us on the bankless journey. Thanks a lot.