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BitMEX Crypto Trader Digest June 28, 2019 android-chrome-512x512.png
From the desk of Arthur Hayes
Co-founder & CEO, BitMEX

From The BitMEX Security Team

Important Security Advisory Update, June 2019

We have observed an increased number of unauthorised attempts to access customer accounts. We would like to remind all customers and users to please protect your BitMEX and personal accounts by: using strong and unique passwords; enabling Two-Factor Authentication (2FA) for all your accounts; and using a password manager.

Asia Blockchain Summit 2019 in Taipei

On 27 June 2019, we set a new record for crypto: >$1B open interest on XBTUSD, >$13B traded on XBTUSD, >$16B on all BitMEX products. Yet, Nouriel Roubini still believes that cryptocurrencies are a farce. Watch him face-to-face next week in Taipei's Asia Blockchain Summit vs our CEO, Arthur Hayes.

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All Hail Libra

Obviously BitMEX must weigh in on the implications of Facebook's new Libra project. BitMEX Research and myself have differing views on what Libra is, and its future implications for the financial services industry. I hope that our analysis stands out above all the other pundits offering their opinions on the same topic.

From The BitMEX Research Team

Facebook Takes on ETF Giant Blackrock, with a Fixed Income ETF called Libra

f5d1d170-1d99-4393-82c0-c2e5ee985a68.gif

Abstract: 
In a bold move, social networking giant Facebook, has challenged the traditional finance and ETF industry, with its “Libra coin", or as we call it the "Libra ETF". We note that there are many unanswered questions about Libra, which may lack transparency, when compared to traditional ETFs. Another key disadvantage of Libra is that unlike with legacy ETFs, investment income is not distributed to unit holders. We conclude that although Libra has significant disadvantages when compared to traditional ETF products, Facebook's wide consumer reach with platforms such as Whatsapp and Instagram could give Libra a key commercial advantage.

(Facebook vs Blackrock – The battle for the ETFs)

Overview

The structure of Libra is analogous to the popular Exchange Traded Fund (ETF) model, where unit holders are entitled to the financial returns of a basket of financial assets. The units are tradable on exchanges and a select group of authorised participants are able to create and redeem units using the underlying assets.

As we pointed out in our February 2019 piece, the ETF industry has enjoyed considerable growth in the last decade or so, in particular in the area of fixed income (See figure 1 below). In June 2019, in a bombshell moment for the ETF industry and challenge for the established players such as Blackrock and Vanguard, social media and internet conglomerate Facebook, entered the game. In a direct challenge to Blackrocks’s “iShares Core U.S. Aggregate Bond ETF” (AGG), Facebook announced plans to launch a new ETF, the “Libra ETF”, also focused on fixed income and government bonds.

Figure 1 – Size of the Top Bond ETFs Targeting US Investors – US$ Billion

a62bf173-7baa-47f7-ad06-d7e2c17437bf.png

(Source: BitMEX Research, Bloomberg)

(Note: The chart represents the sum of the market capitalisations of the following bond ETFs: iShares Core U.S. Aggregate Bond ETF, Vanguard Total Bond Market ETF, iShares iBoxx $ Investment Grade Corporate Bond ETF, Vanguard Short-Term Corporate Bond ETF, Vanguard Short-Term Bond ETF, Vanguard Intermediate-Term Corporate Bond ETF, iShares J.P. Morgan USD Emerging Markets Bond ETF, Vanguard Total International Bond ETF, iShares MBS Bond ETF, iShares iBoxx $ High Yield Corporate Bond ETF, PIMCO Enhanced Short Maturity Strategy Fund, Vanguard Intermediate-Term Bond ETF, iShares Short-Term Corporate Bond ETF, SPDR Barclays High Yield Bond ETF, iShares Short Maturity Bond ETF)

Comparing the new ETF structure with the traditional space

In figure 2 below, we have analysed and compared the new innovative Libra ETF to a traditional ETF, Blackrock’s iShares Core US Aggregate Bond ETF (AGG). Our analysis shows that, although the Libra product is new, much of the relevant information, such as transparency of the holdings and frequency of the  publication of the NAV, has not yet been disclosed.

The analysis also highlights that Libra may suffer from unnecessary complexity with respect to portfolio management. The fund appears to be managed by the Libra Association, which consists of many entities in multiple industries across the globe. These same entities are responsible for issuing the ETF and the list of companies is set to expand further. At the same time, the investment mandate is unclear. In contrast Blackrock’s fixed income ETF product has a clear investment mandate, to track the Bloomberg Barclays U.S. Aggregate Bond Index, which is managed independently of the ETF issuer.

Perhaps the most significant disadvantage of the Libra product, is that unit holders do not appear to be entitled to receive the investment income. This contrasts unfavourably with Blackrock’s product, which focuses on an almost identical asset class and has an investment yield of around 2.6%. Defenders of Libra could point out that the expenses need to be covered from somewhere and that the Libra’s expense fee is not yet disclosed. However, the ETF industry is already highly competitive, with Blackrock charging an expense fee of just 0.05%. This expense fee is far lower than the expected investment yield of the product, at around 2.6% and therefore the Libra ETF may not be price competitive, a key potential disadvantage for potential investors.

Figure 2 – Libra ETF vs iShares Core U.S. Aggregate Bond ETF (AGG) – Detailed Comparison

  Libra ETF

iShares Core U.S. Aggregate Bond ETF (AGG)

Launch date June 2019 September 2003
Issuer The Libra Association/Facebook Blackrock
Assets Under Management Unknown

US$63.5 billion

Asset class

Fixed Income

Bank deposits and government securities in currencies from stable and reputable central banks

Fixed income – Investment grade government and corporate bonds
Underlying Index Unknown/Not applicable Bloomberg Barclays U.S. Aggregate Bond Index

Portfolio managers

The Libra Association, based in Switzerland will manage the reserve. The investment mandate is not currently disclosed. The current members are as follows:
  • Mastercard
  • PayPal
  • PayU (Naspers’ fintech arm)
  • Stripe
  • Visa
  • Booking Holdings
  • eBay
  • Facebook/Calibra
  • Farfetch
  • Lyft
  • MercadoPago
  • Spotify
  • Uber
  • Iliad
  • Vodafone Group
  • Anchorage
  • Bison Trails
  • Coinbase
  • Xapo
  • Andreessen Horowitz
  • Breakthrough Initiatives
  • Ribbit Capital
  • Thrive Capital
  • Union Square Ventures
  • Creative Destruction Lab,
  • Kiva
  • Mercy Corps
  • Women’s World Banking

James Mauro and Scott Radell, with a clear constrained mandate to track the index

Fees

Unknown

0.05%

Investment yield

Unknown

2.6%

Use of investment income

Unit holders are not entitled to investment income Investment income will:

first go to support the operating expenses of the association — to fund investments in the growth and development of the ecosystem, grants to nonprofit and multilateral organizations, engineering research, etc. Once that is covered, part of the remaining returns will go to pay dividends to early investors in the Libra Investment Token for their initial contribution

Attributable to ETF unit holders

Available exchanges

Currently None

The Libra Association

will encourage the listing of Libra on multiple regulated electronic exchanges throughout the world

NYSE

Creation/redemption basket size

Unknown

100,000 units

Authorized Participants (entities able to create and redeem units)

Authorized resellers, not currently disclosed

Investment Banks

Fund auditor

Unknown

PwC

Information about holdings and Net Asset value (NAV)

Unknown

Full disclosure (Published daily)

(Sources: iSharesLibra)

We have also analysed the two alternatives from a technical perspective. As figure 3 below indicates, the key difference is that control of Libra tokens may in part be managed by digital signatures. As long as no whitelist of addresses is implemented, this may provide some advantages:

  • Pseudonymity
  • A limited amount of censorship resistance
  • Relatively easy integration with cryptocurrency exchanges

However, as we mentioned in our Tether report in February 2018, history has shown that these characteristics can cause platforms to ultimately face a choice between implementing KYC or face being shut down by the authorities. Facebook has already censored politically controversial figures on its main platform, therefore it may appear likely the extent to which Libra ETF units are managed by public private key cryptography is significantly constrained or eventually becomes phased out.

Figure 3 – Technical and cryptographic considerations

 

Libra ETF

iShares Core U.S. Aggregate Bond ETF (AGG)

Consensus system

Not applicable (An ETF does not require a consensus system)

Blockchain

Not relevant (Grouping records of ETF transactions into a chain of blocks linked together by hashing, is inconsequential for ETFs)

Control of units based on digital signature

Possibly:

The Libra Blockchain is pseudonymous and allows users to hold one or more addresses that are not linked to their real-world identity

No

(Sources: iSharesLibra)

Conclusion

Despite the key disadvantage, namely that Libra unit holders are not entitled to the investment income, many industry analysts are carefully examining the impact Libra could have on the traditional ETF industry and existing electronic payment systems.

While our comparison to ETFs is a bit tongue and cheek, it does highlight that the structure of the product has similar attributes to existing financial products. We therefore think it is an appropriate comparison, and if Libra wants to be competitive, it should emulate some of the governance and fee characteristics of traditional ETFs.

However, Libra could attract clients due to integration with platforms such as Facebook, Whatsapp and Instagram. If Libra does retain the property of allowing coins to be controlled by private keys, this is an interesting development and the coin is likely to gain share from tokens such as Tether. However, in our view, in the long run, it is likely Libra either disables this feature or makes it technically difficult, such that only a tiny minority of users have these “non-custodial” wallets. If that happens, Libra is nothing more than a high fee ETF.

Libra: Zuck Me Gently

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The event horizon has passed. With Libra, Facebook begins its foray into the digital asset industry. Before I begin my analysis, let’s get one thing straight; Libra is not decentralised nor censorship resistant. Libra is not a cryptocurrency. Libra will destroy all stablecoins, but who gives a fuck. I shed no tears for all those projects that somehow believed there was value in a an unheard-of sponsor creating a fiat money market fund that rode on a blockchain.
 
Libra could lay commercial banks and central banks low. It might reduce their usefulness to a dumb regulated warehouse for digital fiat money. And that is exactly what should happen to these institutions in a digital age.

Why Do Commercial Banks Exist?

Banks came about during a time of great danger for members of the human society. In feudal Europe you most likely worked dawn-till-dusk on the farm. Any meagre savings you or your feudal lord amassed were constantly under siege. Given that money was physical in nature, if you or your lord left the protection of the town, theft was likely.
 
Safety of assets has been the most important value proposition for traditional banks. They could store physical assets and records safely in their vaults. Therefore, governments and wealthy individuals stored money and assets with banks. Banks were and are engaged in a massive confidence game. That is why bank building edifices portray a certain fortified grandeur. In a generation, your assets will still be there, intact and ready for use.
 
Through their partnership with the government, banks obtain a license to issue credit and expand the money supply. They also rely on the legalised violence of the government to enforce contracts. Don’t pay the bank back, they will confiscate the encumbered asset. Should you defy the courts, a government goon will happily press boot to neck, and ensure your compliance.
 
In the last decade, human civilisation’s money and assets quickly transitioned from analogue to digital representations. Money and representations of ownership travel electronically rather than on the back of a horse. If assets and money are now digital, do we need institutions that provide physical rather than digital security?
 
As we have seen, commercial banks are terrible at securing digital information. Pick your large too-big-to-fail bank, and there will be a story about the “leakage” (euphemism for “we have no fucking clue how to safeguard your digital property”) of customer data.

Whoever has the customer, has the value

Previously banks held the most valuable information about customers. They had your whole financial history, and information about where you lived and what you bought.
 
In the past ten years, social media companies through voluntary actions of their users, amassed the most amount of personal information in human history. We share every detail of our lives on Facebook, Instagram, Google, Twitter, WeChat, LINE, Kakao Talk etc. We send billions of messages on centralised chat programs controlled by those same institutions as well. They now own the customer.
 
The modern consumer technology companies own billions of the wealthiest customers’ data. Previous to now, these companies made money on advertising and selling a product. But as with all businesses, once you are successful capturing customers, you start offering financial services.
 
Facebook has almost 2 billion daily active users. It makes complete sense to own the financial existence of their chattel. That is Libra.

Libra Deconstructed

Libra is a stablecoin backed by a basket of fiat currencies. The fiat currencies sit in a dumb regulated commercial bank. Libra allows a privileged few the ability to create and redeem Libra at its Net Asset Value (NAV). Libra rides on a blockchain where certain parties operate permissioned nodes. These parties included VC firms, technology companies, retail merchants, cryptocurrency exchanges, and most importantly commercial banks and credit card processors.
 
Libra may invest into short term government bonds, or into anything the Foundation board allows. The income earned is not passed onto the pleb Libra users, but the node operators and Libra investment token investors. The Foundation is the governing body of the Libra ecosystem. The members are selected based on the industries they represent, and their economic investment into the ecosystem. 
 
Libra does not connect real-world identities to addresses. However, you can bet that converting assets into Libra will encounter KYC. And let’s be clear, any request from a government agency to freeze a transaction will be met with compliance. Therefore, do not use Libra to buy your mood-altering substance(s) of choice.

Impact on Consumers

Many of Facebook’s users reside in places with low financial services penetration. Imagine a world where a Filipina helper can purchase goods sold in Europe with Libra. She most likely does not have great banking services where she works as an overseas foreign worker. Therefore, purchasing goods from foreign countries over the internet is difficult. With Libra, there is no issue.
 
The merchant in Europe receives payment in a basket of fiat currencies they already deal with. This transaction can happen completely inside of one of Facebook’s social media properties like Instagram or Whatsapp.
 
Facebook or a new financial services company it creates, can issue loans at the point of sale denominated in Libra. A user can opt-in to allow Facebook to use all its data on the individual to compute a credit score. Using that credit score, Facebook will lend Libra at a rate to purchase goods from merchants selling on the Facebook platform. Voila, the poorest members of our global society can experience the joys of purchasing mass-produced Chinese knick-knacks on credit. Welcome to Pax Americana!

Impact on Commercial Banks

Commercial banks make money lending. They use retail deposits to make these loans. Unfortunately, in this digital age, they no longer have the best information set about these retail depositors. The social media companies do.
 
Therefore, the Facebook, Google, and Alibaba’s of the world can originate a loan cheaper and offer a lower interest rate than a commercial bank. Libra and the plethora of copycats to come, allow technology companies to use a digital fiat representation in their ecosystems to extend credit and offer all of the most profitable banking products at a much lower cost. These global tech behemoths have billions of free cash flow on their balance sheets to lend.
 
Commercial banks can become node operators or regulated warehouses for the reserve assets of the stablecoin in question. There is still economic value in both of these verticals, but consumer technology companies will now sell the most profitable financial products themselves.
 
Any bank should be on notice, Libra and its clones are existential threats to their business models. Many will cheer as banks’ profit centers are eviscerated. But maybe society is trading one devil for another.

Impact on Central Banks

Commercial banks are not needed at their current largesse in a digital economy. With Libra, Facebook is assuming the role of a central bank. The Libra reserve is managed by a third-party foundation. The reserve managers choose the fiat currency weights, and how funds are invested. Sounds a lot like the job scorecard of a central bank governor.
 
Consumer tech companies can now issue, from their own balance sheet, credit directly to consumers. The only difference with this model is that they, for now, are not able to actually create money like commercial banks. This is the flow:
 
1.     Take retained fiat earnings, and exchange for Libra with an authorised primary dealer.
2.     Lend Libra to your customer in exchange for a good or service you offer.
3.     Obtain Libra + interest in Libra back from your customer.
4.     Sell Libra in exchange for fiat with an authorised primary dealer.
 
The money supply does not expand. That is the one major divergence from how a central bank issues credit into an economy. Central banks’ lending in most cases increases the aggregate supply of money.
 
Why trust a few crusty old men and women to manage the monetary health of the global economy. Let’s trust Zuck!
 
I have no love lost for US Representative Maxine Waters’ idiotic statements and actions on the US House Financial Services Committee. But her and other government officials’ outbursts of concern are not driven by altruistic feelings towards their subjects, but rather a fear of the upending of the financial services industry that lines their pockets and keeps them in office. The speed at which government officials rushed to admonish Libra tells you there is some potential positive value to human society embedded in the project.

Libra and Financial Privacy

It is amusing to see how many people rushed to complain about the potential loss of financial freedom Libra could represent. This fear is misplaced, financial privacy is already non-existent, nor will it ever exist in a digital fiat money system. Whether it be Facebook, The Fed, or The PBOC, centralised electronic fiat money is coming - cash will be outlawed.
 
The great thing about the launch of Libra is that it forces those concerned about the loss of financial privacy to explore alternatives. Bitcoin and other cryptocurrencies will benefit as curious plebs contemplate how secure financial privacy in this new digital age.
 
Libra and the conversations it sparked, is the best news for Bitcoin. Two billion people will now embrace and potentially be frightened of a corporate overlord controlling their financial wellbeing. Curiosity is the best food for the Bitcoin bull market.

Through their investments in augmented and virtual reality, it appears that Facebook wishes to create a completely new digital world. Libra could be the financial mana that powers this virtual existence. Let’s hope that while we are vegetating in our haptic pods, our physical shells don’t get Zucked too hard. Please Zuck me gently, and Zuck me long time.

Risk Disclaimer

This article should not be copied or reproduced in whole or in part. The information contained in this article does not constitute research or a recommendation. 

Neither BitMEX nor any of its affiliates make any representation or warranty, as to the accuracy or completeness of the statements or any information contained in this article and any liability therefor (including in respect of direct, indirect or consequential loss or damage) is expressly disclaimed. This is not providing any financial, economic, legal, accounting or tax advice or recommendations.  In addition, the receipt of this article is not to be taken as constituting the giving of investment advice nor to constitute such person a client of BitMEX.

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