Can the blockchain to prevent the next financial crisis?

The role of Central banks is to manage the national currency, money in circulation and interest rates. The United States had no Central Bank until 1913, when Woodrow Wilson signed the Federal reserve act. Since then, the Federal reserve is responsible for the elasticity of the US economy due to the expansion and contraction of liquidity in the form of new credit and paper money supply. Retail and institutional banks abide by the strict rules of the fed, which in turn affect the daily lives of entrepreneurs, corporations, investors, markets and consumers.

Today, the United States and most developed economies are in a precarious position due to the reduction of liquidity, which is a direct result of excessive stimulation. There are signs that the current financial system again begins to crumble, but unlike 2007, there is now a new industry built on the basis of safety, liquidity and stability of our money.

What is the situation

Operations with repurchase agreements, also known as “REPO” for the last few months, often flashed in the headlines of the media, including Bloomberg, Financial Times, Business Insider, and just a few dozen. But what “REPO”?

In short, lending a REPO is a way to extend credit in the banking system to the fed. Interest REPO rate is the interest rate that banks charge each other for borrowing funds. As a rule, they follow the rates of lending to the fed overnight. However, I began to see an increase in REPO rates upward, which indicates the existence of problems with the proposal from banks, issuing short-term funds to other banks, and the growing demand from the banks and corporations that require short-term cash.

In 2007 it was possible to see firsthand that, when liquidity is depleted, banks failing, markets falling, unemployment is increasing and production volumes are reduced. Since then, the fed filled the gap in Bank liquidity by printing dollars, calling it “quantitative easing”. After ten years supply of easy money, the fed changed course in 2018, increasing interest rates and selling bonds to repay debts. Reducing the supply of free money, combined with the increase in rates forced the banks to compete for liquidity, which several times shook the markets over the last twelve months.

In June, the fed again reversed course, halting the decline of balance and lower interest rates. In September, we first saw the effects of over stimulating the money supply within 10 years, and then tried to return to normalcy. Although it was impossible to see which banks were the culprits, several banks have laid their cards because the interest rates on interbank loans significantly exceeded the established fed funds rate.

In the economy, which were provided free money and debt, lack of credit and dollars can quickly develop into a serious problem. With interest rates already close to zero, it is difficult to understand which tools will use the Federal reserve, when the situation will become heavy.

The emergence of bitcoin

Bitcoin appeared 10 years ago, in 2009, and introduced a new asset class which has become an alternative basic Finance.

Over the years the ecosystem has developed from the individual sovereign possession of the money, before the introduction of software intermediaries, such as “smart contracts”, which further eliminates unnecessary human intervention. Bitcoin and Ethereum and new technologies that they brought to life – showed the beginning of what seems to be international cooperation, if we remove the extra layers centralized in our economic systems that quickly find themselves functionally obsolete.

In the transition from the imperfect financial system to a more industrialized, decentralized system based on the blockchain, it is necessary to achieve balance. We saw the disadvantages of pure centralized through “quantitative easing”, but to make the assumption that pure decentralization will provide a utopian solution to global Finance, is a mistake.

Decentralized technologies provide tools to reduce costs and improve efficiency where existing technologies can’t do, but there are elements of the existing system, including people, corporations and governments that are needed for the new system.

Global solution to the issue of liquidity

The emergence of bitcoin has led to the creation of a whole group of blockchains, including the XRP Ledger, Ethereum, EOS, Tezos, Cardono and others, each of which has its particular use and management. Common – the infrastructure to create new financial instruments based on payments, lending, stabilizing currencies, tokenization and decentralized exchanges. In particular, the Ethereum blockchain and the XRP Ledger provide tools to mitigate the impact of another global financial crisis.

Perhaps the best definition of Ethereum – world computer educated an infinite number of computers communicating with each other. It offers the advantage of global applications exactly as they were programmed, and without the risk of intervention by individuals, governments or financial institutions. In the era of endless paper printing creating a safe and stable currency that people can use in daily trading, will be a key factor when we start to observe the effects created by the Central banks.

One of the projects, which is based on Ethereum and is focused on stabilizing the currency – is stablecoin Dai (DAI), MakerDAO – type decentralized Autonomous organization, governed solely smart contracts and codes, not the managers. The concept of DAI is quite simple: it is a symbol that is similar to bitcoin and ether; however, it is designed to have little or no volatility. Let’s start with the fact that DAI is trying to be stable against the U.S. dollar. This allows consumers worldwide to make transactions without worrying about fluctuations in the value of their currency. Over time, DAI and other stabilini you can diversify to hedge against falling Fiat currencies and begin to become attached to assets, such as gold or other commodities.

The creation of a stable currency today it is important in such places as Argentina, where the national currency has depreciated by 51% against the US dollar only in 2018. When these same effects will affect such currencies as USD, a stable currency, the consumer will be an important factor.
To consumer digital currencies worked, banks need to put their infrastructure in this new ecosystem. This will not happen overnight and will require a transition period between the existing system and the new.

An example of a company that is modernizing the entire industry in the interests of business and consumers and is positioning itself to cope with the upcoming liquidity crisis is a Ripple. True to its slogan – “money Instantly roaming all corners of the world” – Ripple is a system of gross calculations in real time, a network of currency exchange and money transfers.

Currently, there are a lot of inefficient cross-border transactions between banks. Slow transactions and high fees are a direct result of the fragmentation that exists between heterogeneous actors. Try to transfer money to a friend or family member abroad, and you will quickly see firsthand the disappointment of this obsolete technology.

It is important to note that the company is different from Ripple XRP cryptocurrency – a digital asset in the blockchain, XRP. The digital asset and the registry was formed before the advent of the company, but they have common shareholders. Although the company uses XRP for liquidity purposes, it does not control the currency, or the registry.

Ripple sells RippleNet, an enterprise solution for banks and institutions around the world. RippleNet brings together the existing community banks into a single network that provides efficient, liquid and inexpensive transaction. RippleNet is a payment network based on the technology of the blockchain, with more than 200 banks and payment providers worldwide, comprising of three main products: xCurrent, On-Demand Liquidity (previously xRapid) and xVia; each performs a specific role.

xVia provides banks and corporations one method instant sending of global payments, while xCurrent provides an instant level of payment between these banks. On-Demand provides Liquidity the level of liquidity between the institutions, so they can reduce the volume of paper money, which they must keep on hand.

The first signs of deficiency appeared on the REPO markets in 2007. As we can see again that these signs are surfacing, On-Demand Liquidity may be the solution that we did not have at the end of 2000-ies.

How does On-Demand Liquidity?

Basel III has changed the normative logic of calculating the ratio of tier I capital. Before the crisis of 2007, regulators could assume that banks have enough liquidity to remain solvent; however, after the financial crisis and the collapse of several banks like Lehman, it ceased to take place. New rules have required banks to have a pre-funded account or existing pools of liquidity to move Fiat currency between banks in disparate countries.

For example, Bank X in the United States and the Bank Y in Mexico now have to keep a percentage of their deposits in US dollars or Mexican pesos to move currency between each other. This requirement links billions of dollars in working capital and is an ineffective solution to ensure liquidity.

xCurrent places a temporary block between Bank X and Bank Y. Bank Y When you want to get dollars from Bank X, instead of Bank X held those dollars in reserve in the Bank Y to ensure adequate liquidity, they can sell USD for XRP. XRP can be sent to Bank Y, which can then sell it in exchange for US dollars. Both banks can maintain complete control over their reserves, returning this working capital back into their own institution.

Since we expect the emergence of new signs of a global shortage of liquidity, it may be worthwhile to pay attention to companies like Ripple. Probably, this time we will be able to avoid the pitfalls of the last crisis, while providing an infrastructure for productive and healthy financial future.

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Author: Vitalik

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