The New Financial System

A CBDC Delivered by a Trojan Horse

In July of this year, a peer-to-peer payment system will capture hundreds of millions of users virtually overnight.

It’s what the crypto industry has been working towards since Bitcoin launched 14 years ago.

It’s impressive to think about. Millions and millions of users moving money every single day. And being onboarded overnight. Especially when we consider Bitcoin moves tokens from half a million wallets each day. This event represents an orders of magnitude change in adoption.

But this adoption is not going to happen in Bitcoin or in crypto.

I’m referring to the first iteration of the United States Central Bank Digital Currency (CBDC). The digital dollar.

The foundation for this moment has been laid over the last year. We can see the news events happening on the agency’s blog for many months now.

But what goes unnoticed is that on March 12, it appears the transition to a new financial system has begun.

No, I’m not referring to Zoltan’s incredible and thoughtful Bretton Woods III mindset… One that does in fact look to be coming true with how Russia and China are strengthening ties via their most recent agreement, in which the Chinese yuan is being used for settlement.

Instead, I’m referring to a method that looks to patch up one of the most glaring issues presenting itself today. The issue each macro analyst points out as being a mountain of gunpowder ready to blow up given these high rates.

I’m referring to the debt issued by the U.S. government.

And it appears the digital dollar will use this as collateral for the currency you send your friend tomorrow.

Your Asset Is the Debt of My Debt

Nearly two weeks ago, the U.S. Federal Reserve (FED) just about guaranteed all deposits. It does not have the legal authority to do so, but the implicit agreement is loud and clear.

It was like the day your father found out you were underage drinking, but trusted your judgment.

But here, it’s not so much the FED trusting the judgment of banks. Consider it more like a trojan horse for what we hit on earlier…

24/7/365 payment infrastructure.

If you remember what the FED said regarding the new program called “Buy The Fricken’ Print,” or BTFP for short… It laid out what can be termed liquidity preference. It mentioned that if a bank holds eligible collateral “see 12 CFR 201.108(b)”…

(googling this government glossary term…)

It’s a long list of bloated agencies and entities deemed to be the government in general. You can see for yourself here. Instead of taking the time to read for yourself, just take this summary as sufficient: “U.S. Treasuries, U.S. agency securities, and U.S. agency mortgage-backed securities.”

Debt that is strategic to the government.

This debt is what will power the new digital dollar payment network. To understand just how odd this is, I’ll use a crypto-friendly example.

Most of us reading this ultra-caffeinated blend of verbiage can understand how MakerDAO works. You take an asset like ETH, lock it up, and borrow against it. That borrow is denominated in DAI. There are other forces at work, but this is the TLDR. And when the loan cannot be repaid or the loan is repaid, the debt gets settled.

It’s a conscious effort to not create the system that I’m about to get to.

Let’s now consider an alternative. One where an entity can create a note saying it will repay ETH… ETH that it never earned or held in the first place. Then said it would pay interest on this amount. And it already had a mountain of debt that it has zero chance of paying.

Seems fine, right? Well, it’s more common than you think.

The scenario I’m referring to describes U.S. Treasuries. It’s the asset that looks to be sitting at the center of what will be the FedNow program. But why?

Recall, the FED just gave liquidity preference to this government-issued debt. They did this exchange for debt… I mean asset… so banks can pay depositors… meaning they can borrow against this debt.

Holding a bond that promises a future payment at a later date is an asset. But the debt we are talking about is from an entity that will keep issuing more debt.

And since the Treasury gets held by the FED, and the bank’s borrowing from the FED, that represents two degrees of borrowing where the interest potentially flows to the FED (not 100% sure if the bank is paying interest on its loan here, so this might be a wrong assumption).

If true here, it’s no wonder the FED wants to raise rates. It is literally sucking money out of the economy with double-gauged vacuums in both hands.

But that little tidbit is not why I went ahead and started to sip on spirits past midnight to roll these words off the fingertips.

It’s something more ludicrous.

The Trojan Horse Has Already Arrived

On March 12, the Trojan Horse rolled into the financial system.

Silicon Valley Bank was saved via a gift from the FED to make sure depositors are made whole.

It was a welcomed moment for many in the technology sector, specifically Web2.

The reality is this was a Trojan Horse for the new financial system. The liquidity preference we hit on earlier was cemented on this day.

From this day forward, banks will have a decision to make: Hold a U.S. security like a Treasury, or something else. Given the FED has no intention of lowering rates, the main issue regarding time deposits will not go away.

Time deposits is simply what anybody who saw the classic It’s a Wonderful Life understands. The black-and-white movie from 1946 airs on repeat during December, and serves as a nice reminder that the money you deposit at a bank is tied up in a loan that was given to your neighbor for the business they just opened. Meaning it’s a confidence game.

This is fine on small scales where you act as a check-and-balance to your neighbor. If he doesn’t pay, he sees you during church on Sunday - remember, this is America in the 1940s.

But this is not the financial system of today. Instead, these time deposits are tied up in securities that expire in 3, 6, or 12 months. If the bank needs to sell these deposits, they get cents on the dollar.

This is a loss for the bank. Too many of these, and then the bank no longer has a balance sheet that adds up in the black.

But remember, banks now have a get-out-of-trouble card to play thanks to the Trojan Horse. The BTFP helps banks get par value on their collateral of U.S. Treasuries.

So why would the FED be this willing to essentially backstop any bank that holds collateral like a U.S. Treasury?

Enter stage right into your life in July of this year…

FedNow.

Let me serve as a spokesman for a moment to what is coming your way:

Are you tired of waiting days for your money to be there? Do you want to make sure your bank has your hard-earned money? Do you enjoy the ease of sending payments to your friends directly using your phone?

Wait no more…

FedNow is a 24/7/365 day service that lets you send instant payments to your neighbor across the street or friend on the other side of the globe.

This is a never-before-seen solution! And don’t worry, this is backed by the full faith of the government to ensure instant liquidity, settlement, and real-time extension of credit to your bank via intraday settlement.

If you haven’t figured it out by now, BTFP is introducing the concept of holding collateral that can be used to borrow money from the FED to meet intraday settlements… It’s like Circle’s USDC being fully backed by U.S. Treasury’s while also being able to meet any redemptions at its door step. It’s a full on credit facility to address the time deposit issue banks suffer when rates rise.

Government debt is held by banks that back dollars flowing through the FED’s payment network. This looks to be where the U.S. v1 of its CBDC is headed.

If true, it means there is not enough debt being issued for this new system. Cue up the conversation on the debt ceiling with Janet Yellen. It’s now time. We are likely in store for a unique solution for this that helps patch some gaps in showcasing a word-for-word discussion on how collateral works in the FedNow program.

We’ll know more in as little as a week because the Board of Governors of the FED said,

“The first week of April, the Federal Reserve will begin the formal certification of participants for launch of the service. Early adopters will complete a customer testing and certification program, informed by feedback from the FedNow Pilot Program, to prepare for sending live transactions through the system.”

Just be ready for this as we will likely dive into whether or not FedNow and the debt issues go hand in hand either here on on Twitter.

What does this mean for Bitcoin and markets at large? This was the “oh shit” moment that will pause rate hikes we hit on during Macro Cycles. Yes, we had a 25 bps uptick this week. That felt more like JPow just saving face with the “I told you so” critics.

The reality is Jerome is preparing to shift from a rate hiking environment to a pause. And now the Trojan Horse has been delivered. It is time to raise the debt ceiling.

Crypto will continue to get the bastard child treatment until FedNow is fully launched. View a lot of regulatory bark as a way to ensure better adoption of this new payment system. Here’s the FED almost giving away their hand,

“Montgomery noted that availability of the service is just the beginning, and growing the network of participating financial institutions will be key to increasing the availability of instant payments for consumers and businesses across the country.”

And just as I read through this one last time I saw Yellen’s comment about debt…

They are preparing their move here.

So from now until about the end of summer, authorities will be emptying their cannons at the blockchain industry. And if anybody is following along with price charts, a Bitcoin halving is near. Meaning we are likely to be pumping higher as the cannons empty… And Phase 3 of what I outlined in Macro Cycles is on tap to begin in the second half of 2023.

As JJ said at the office recently… Get to printing, Jerome.

Your Pulse on Crypto,

Ben Lilly

P.S. I didn’t have enough time to get into how this liquidity preference via the government may result in banks becoming much riskier with your capital. It’ll push their behaviors to the far reaches of the risk curve to make their bonuses… With your money. SVB seems like an appetizer for the risk management behavior this new direction will push banks towards.

Bank makes profits, bankers win. Bank loses money, tax payers lose even more.