Celsius, Boiling Points and How FDR Would Fix Crypto
Crypto's having a week. Celsius, bank runs and the Great Depression. Lots of funny/tragic tweets.
One thing about writing this Substack: I get a lot of texts from friends whenever crypto markets tank. So on Sunday night, five group chats all sent me this Tweet and asked "WTF?!":
The rumors around Celsius’s pending insolvency have been swirling for weeks. So I can’t say it surprised anyone paying attention. It was also not surprising to see the string of "RIP Crypto" tweets.
Is this it? Have we entered the Great Bear Market? Is it finally Crypto Winter? Have the tokens laid down for the long nap?
Look, I can’t predict the future.
But what I can do - and try to do - is study the past. Because markets have been here before. And, no, I’m not talking about previous crypto bear markets. I’m talking about the Greatest Bear Market of them all: The Great Depression.
The parallels to what is happening with Celsius is unfortunately very clear. What we have here, folks, is a classic bank run. And Bank Runs have this annoying property of becoming contagious. So, in true Charterless fashion, I want to explore what’s going to happen through the lens of what already has.
That means today we’re going to study the Presidency of one of my personal heroes, Franklin Delano Roosevelt.
Confidence Games: The Bank Run of 1932 and the Emergency Banking Acts
In American History, we learn about the Great Depression as though it were a single event. But it’s actually better thought of as a series of cascading crises.
In October 1929, a market panic caused the NYSE to drop >10% on successive days. Fear of an impending collapse motivated bankers to call-in loans they had made to traders. When those traders could not repay their loans, they liquidated their stocks. The market tanked. Investor confidence collapsed. The financial markets settled into a Bear Market.
In Summer 1930, Congress was determined to insulate American farmers from the crisis. So they passed tariffs to protect them. Then the Dust Bowl began. American grown food was hard to come by and international food was now too expensive (thanks tariffs!). Mass hunger became common. The real economy was in massive trouble.
These twin sparks -- financial panic and a spreading famine -- ignited a fire that would burn down the US economy. Because as fear spread, people rushed to banks to withdraw their savings.
Many small rural banks couldn't meet the demand for immediate withdrawals. Bank runs started in small counties. But they spread nationally. On Dec 11, 1932, the Bank of the United States, the nation’s fourth largest bank failed.
This cycle --
investor confidence collapse
Is playing out in crypto markets. It seems to be spreading to the traditional markets, too.
Bank runs are the most damaging part of this cycle. This is where we are after the Celsius debacle. And it's where we were in 1932.
Why are bank runs so insidious?
We’re used to thinking of bank deposits as the safest possible investment. Actually, these days, we don’t think of it as an investment at all. You put your money in the bank for safe-keeping. It is so much more convenient than storing your cash (or your cold-storage wallet) under your bed.
We imagine that somewhere our money is sitting in a vault, ready to be withdrawn whenever we need it.
But that’s not how banking works.
When you deposit your money at a bank, you are actually lending it to the bank to invest on your behalf. In fact, banks barely keep any of your money safe in a vault. In the US, today, they are required by law to keep only 2% of your deposits on hand.
In exchange for your investable capital, the bank historically pays you a small, stable interest rate. So let's say the market is going up 10% per year. You get your 2% interest rate. The bank gets the remaining 8%. The economy continues to grow from the capital investment. Win. Win. Win.
This works well when markets go up. But when the market goes down, we run into a problem. Now the bank not only cannot pay you interest, it has also lost your deposited money. When we can't trust that the money in our bank is going to be there, we lose faith in the entire economy. We panic.
And if we all show up to withdraw all our money at the same time, the bank has 2% of its capital to redeem 100% of its liabilities. Not great. The entirety of the global economy depends on us not doing this. If that were to happen, the entire scheme of the American economy unravels fast.
And in 1932, that’s exactly what happened. Bank after bank failed to meet depositor withdrawals. No one knew if their money was safe.
That was the situation on March 4, 1933 when FDR took the oath of office. On March 5, the new President closed all banks in the United States for a mandatory bank holiday. Then he began to implement his program to stabilize the sector. That plan had four key planks:
Stop the Runs. Force all banks to temporarily close so that depositors could not show up and demand withdrawals.
Provide Capital Injections. The Reconstruction Finance Corporation (RFC) invested in banks to ensure their continued operation.
Separate Speculation from Banking. The Glass-Steagall Act forbid depositor-banks from investing in securities. This restored depositor confidence that their money would not be invested in risky assets.
Guarantee a backstop. The government created the FDIC to insure all bank deposits up to $2,500. This reassured investors that some portion of their deposits were safe.
These actions did not end the Great Depression.
That would take the largest public works program in history and a second World War. But the reforms stabilized the nation’s financial system.
The good news is that the Crypto markets can follow this path to sanity. The bad news is that we’re still in the 1929 stage of the collapse, and sanity may be a long way off.
Brrr it's cold in here, there must be some Celsius in the atmosphere.
So how does this relate to what happened with Celsius?
Let’s start with what the platform actually was. Celsius, at first glance, looks a lot like Coinbase. You can use the site to buy cryptocurrency. You can (until recently) make trades from their site.
But Celsius is actually an unregulated bank.
When you deposit cryptocurrency on Celsius, you are eligible to receive “yields” (also known as ‘interest’). The Celsius team invests your crypto in strategies designed to generate returns.
As with banks, this works well when the market is going up. The Celsius website still promises that you can earn up to 18.7% yields when you deposit your crypto with them.
But when Bitcoin and Ethereum prices started tanking this year, they were no longer able to cover the promised yields on deposits. When rumors about their solvency started to spread, they lost depositor confidence. The result was predictable: a bank run.
As late as Saturday, the CEO of Celsius was still drumming up confidence in his company. He wrote on Twitter:
By Sunday, things had gotten dire. As we know, the Celsius team declared their own mini-bank-holiday:
Oh, and it gets worse because:
1. Celsius borrowed a lot of Bitcoin to make its investments. And those loans are now being called-in. So they are having to sell assets to buy Bitcoin to meet their loan commitments. Because of the structure of the loans, if they do not keep the USD-value of the collateral high enough, they will be forced to sell at low prices. So speculators are trying to drive down the BTC price to make this forced liquidation happen.
2. Celsius has a lot of money wrapped up in "staked Ethereum" a token that will remain (mostly) irredeemable in Ethereum for at least a year.
For Celsius, the upcoming question is clear. Can it use its Holiday to get things back in order? 90% of American’s banked assets survived the Holiday. But 4,000 banks never reopened.
For the broader cryptomarkets, the question is equally clear, without government involvement, who can step in to right the ship?
A Path Toward Sanity
For guidance, we can look to the playbook written by Mr. Roosevelt 90 years ago this Spring.
Bank Withdrawal Holiday
Now, of course, the challenge is we don't have any of those handy centralized institutions to rein-in the market. But we do have the ability for different actors to act to restore confidence. If I were the President of Crypto(™), I would call up some folks to get going. And here would be my plan:
1. Implement Rules-Based Crypto Bank Holidays
It turns out, even as President of Crypto, I can't declare all markets shut down. But what we can do is start signaling/encoding automated circuit breakers.
The NYSE has a similar ‘circuit breaker’ mechanism when stocks drop 7%. Platforms might want to adopt uniform standards for throttling. Waiting to do this until a crisis is... not a confidence booster.
But if these policies are set in advance, they will not look like crisis actions or like clear signs of collapse. They will start to be an essential tool for platforms to break out of negative feedback loops.
2. Capital Injections from the Whales
In the 1930s, the RFC invested in over half of US Banks to shore up the financial sector. A crypto RFC is not going to happen (nor should it). But crypto’s whales have a strong incentive to become a lender of last resort.
And big moves from big movers is not unprecedented. In the 1907 financial panic, JP Morgan and John D Rockefeller led a collection of investors who deployed ~$70M ($2.2 B in inflation adjusted dollars) to keep the economy afloat.
So how about it, SBF or Michael Saylor or Winklevii?
A targeted investment and buy-order re-establishes a floor. And for those investors fully committed to the space -- it's in their self-interest to keep the market from imploding. Just as it was in JP Morgan's interest to keep NY from defaulting on its loans.
3. Separate Speculation from Saving
The problem with Celsius is not that different than it was for banks in the 1930s. Everyone assumed their money was 100% safe. It was not. That shock caused a broad crisis of confidence in the system.
That's why the biggest regulatory opportunity in crypto today isn't in blocking certain trades. It's in requiring honest marketing.
I don't have a problem with an investment fund going belly-up after taking on speculative bets. But I do have a problem with hurting retail investors who were told their funds were secure. And that's what has happened with both Terra and Celsius.
That’s a problem. And it’s one that can only be corrected by regulation.
The Lummis-Gillibrand bill would be a step in this direction. Any asset positioning itself as a “Stablecoin” would need to be backed by 100% real fiat currency. Custodial investors (like Celsius) would need to disclose their risks and advertise truthfully. That means no-more-pretending-you’re-a-savings-account if you’re really an investment scheme.
Even the true crypto bros should be able to support this level of regulation. The blockchain project is a bet on transparency to regulate markets. The entire sector should welcome these disclosure rules as directly in-sync with the values they profess.
4. Provide Insurance
It’s highly unlikely that the FDIC is ever going to insure crypto custodial accounts. But that doesn’t mean that the broader sector shouldn't invest in its own insurance programs.
Insurance hedges are not foolproof (ask AIG how that went in 2008…), but they could help defray risk.
Transparent insurance markets provide a clear signal on risk. For inspiration, the market should look to Nexus Mutual's smart contract failure markets. Providing “nutrition labels” on various products’ safety will be essential to smooth operation.
It’s a sobering thought that we’re living through the early days of a bank run crisis. But take heart – capitalism emerged stronger than ever after the Great Depression. Tough times breed strong systems. That said -- it sure would be nice to proactively learn from the past rather than reliving every financial crisis. But to paraphrase Faces:
"Poor young [crypto], there's nothing I can say. You'll have to learn, just like me, and that's the hardest way."
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