Money Stuff: Crypto Might Get Some Banks

A theme that I have written about a lot around here is that US banking seems to be getting narrower. Traditionally, banks are in the business of (1) taking deposits and (2) making loans, and that is a famously risky combination: If all the depositors want their money back, the bank doesn’t have it, and there can be a destructive bank run. There are various ways to mitigate this problem — liquidity regulation, deposit insurance, the central bank as a lender of last resort — but it keeps popping up.

There is one theoretical way to get rid of the problem entirely: You could separate the business of taking deposits from the business of making loans. Some companies — call them “narrow banks” — could be in the business of taking deposits and just holding onto them, in literal piles of cash or more plausibly in the form of electronic reserves at the Federal Reserve. Other companies — call them “loan companies” — could be in the business of making loans, but not using deposits as funding. Those companies could raise funds from investors who knowingly take the risk of making loans and lock up their money for the long term. Deposits would be safe, loan funds would not be subject to runs, and the central risk would be removed from banking.

This is a very old idea that has gotten a lot of interest from academics, but it is controversial. It is possible that the central risk of banking — taking safe deposits and using them to make risky loans — might be desirable, that separating the businesses might be bad. I often quote a 2011 Steve Randy Waldman post at Interfluidity:

One purpose of a financial system is to ensure that we are, in general, in a high-investment dynamic rather than a low-investment stasis. In the context of an investment boom, individuals can be persuaded to take direct stakes in transparently risky projects. But absent such a boom, risk-averse individuals will rationally abstain. Each project in isolation will be deemed risky and unlikely to succeed. Savers will prefer low risk projects with modest but certain returns, like storing goods and commodities. Even taking stakes in a diversified basket of risky projects will be unattractive, unless an investor believes that many other investors will simultaneously do the same. …

This is a core problem that finance in general and banks in particular have evolved to solve. A banking system is a superposition of fraud and genius that interposes itself between investors and entrepreneurs.

If you tell people “put your money in the bank, where you can get it out anytime, guaranteed by the government,” (1) they will do it and (2) the bank can use the money to make risky loans to entrepreneurs and young home-buyers. If you tell people “put your money in a fund to make risky loans to entrepreneurs and young home-buyers,” they might just not do it; credit and the economy would contract. Banks take money from savers who don’t want to take risks, and use it to fund risky projects, a pro-social sleight of hand. Waldman:

The analogy I would choose is finance as placebo. Financial systems are sugar pills by which we collectively embolden ourselves to bear economic risk. As with any good placebo, we must never understand that it is just a bit of sugar.

That’s what I thought a few years ago. It also seems to be roughly what the US Federal Reserve thinks. In 2018, an entity called TNB USA Inc. tried to open a narrow bank. It applied for an account at the Fed, where it would just park its depositors’ money. It wouldn’t make any loans or investments; all the money would just sit at the Fed, which pays interest on reserves. The Fed dragged its feet on opening an account for TNB, and explained its reasoning 2019, arguing that “narrowly focused depository institutions” like TNB, which “hold a very large proportion of their assets in the form of balances at Reserve Banks,” could “have the potential to complicate the implementation of monetary policy” and “disrupt financial intermediation in ways that are hard to anticipate.”

Again, in 2018 and 2019, this struck me as largely correct: If everyone could have totally safe, Fed-backed, interest-paying deposits, surely there would be less demand for bank deposits, fewer loans and less financial intermediation.

But since then it does seem that banking has gotten narrower. On the deposit side, you kind of can get totally safe deposits. Treasury money market funds don’t quite park their cash at the Fed and earn interest, but they get pretty close, investing in short-term Treasury securities and reverse repos at the Fed. If you don’t like the risk of depositing money at a bank — and after the Silicon Valley Bank run in 2023, many people don’t — you can get much closer to narrow banking via money market funds. And on the lending side, the enormous boom in private credit proves that in fact there is a ton of demand from investors who want to knowingly take credit risk. You can get lots of loans — risky leveraged buyout loans, but also consumer loans and mortgages — without the placebo of banking. 

So banking is getting narrower, though it is not yet narrow in any absolute sense. Private credit is still much smaller than the banking system, and private credit firms themselves often borrow from banks to increase their ability to make loans. The Fed’s 2019 objections to narrow banking still apply; the Fed formally turned down TNB’s account application only last year.

But narrow banking pops up elsewhere. One important modern form is stablecoins. A stablecoin is a crypto form of banking: You deposit dollars with a stablecoin issuer, it gives you back tokens entitling you to get your dollars back, and meanwhile it does whatever it wants with the dollars. In the unregulated early days of crypto, “whatever it wants” could be quite spicy indeed, but these days stablecoins are a big business and there is something of a norm of parking the deposits in very safe short-term dollar-denominated assets, ideally Treasury bills or reverse repos or a BlackRock money market fund. If you launched a new stablecoin today and said “we will take your dollars and use them to make loans to emerging crypto entrepreneurs,” you’d have a hard time competing with the big incumbent stablecoins that say “we will take your dollars and use them to buy Treasury bills.” (Especially if, like most stablecoins, you didn’t pay interest.) 

One flavor of this is “central bank digital currency,” which means roughly “a stablecoin run by the Fed and backed directly by Fed deposits.” And my impression is that the Fed does not like the idea of a CBDC, in part for these sorts of financial-intermediation concerns. More generally, my impression is that the Fed does not want a world in which stablecoins are (1) a dominant form of digital money and (2) narrow banking. That is a world in which the alchemy of banking is harder to achieve.

On the other hand, do you want a world in which stablecoins are (1) a dominant form of digital money and (2) not narrow banking? Broad banking? Where the stablecoin issuers do take dollars and use them to make loans to emerging crypto entrepreneurs? What about a world where the stablecoin issuers take dollars and use them to make, you know, leveraged buyout loans, or consumer loans, or home mortgages? Maybe that’s fine? Maybe that’s just banking? Maybe we can just recreate the whole banking system but in crypto?

Anyway the Wall Street Journal reports:

A host of crypto firms including Circle and BitGo plan to apply for bank charters or licenses, according to people familiar with the matter. Crypto exchange Coinbase Global and stablecoin company Paxos are considering similar moves, other people said. 

That comes as the Trump administration moves to incorporate crypto into mainstream finance and Congress advances a pair of bills that would establish a regulatory framework for stablecoins, which let people easily trade in and out of more volatile cryptocurrencies. The legislation would require stablecoin issuers to have charters or licenses from regulators.

Some crypto firms are interested in national trust or industrial bank charters that would enable them to operate more like traditional lenders, such as by taking deposits and making loans. Others are after relatively narrow licenses that would allow them to issue a stablecoin. …

Any crypto firm that obtains a bank charter would become subject to stricter regulatory oversight. 

The obvious story here is that any crypto firm that obtains a bank charter would be subject to stricter oversight of its know-your-customer and anti-money-laundering programs, its capital, its information security, etc., all the stuff that crypto firms sometimes get in trouble for.

But the weirder story here is: If you are a crypto firm that wants a bank charter, do you have to do lending? If you are a stablecoin issuer whose entire business is (1) taking deposits and (2) parking those deposits in Treasury bills, do bank regulators want to give you a charter? Aren’t bank charters for banks that do financial intermediation? Will there be pressure for stablecoin issuers to become real banks, to take deposits and use them to fund loans? Will crypto companies that want to become banks have to be regular banks, not narrow ones? 

This is a little funny because crypto is to some extent a reaction against traditional banking. Satoshi Nakamoto invented Bitcoin in part in disgust at the 2008 financial crisis. And cryptocurrencies are distinct from dollars in that a dollar fundamentally is a debt obligation of a bank, while a Bitcoin fundamentally isn’t; crypto is a form of non-debt money, a way to have money and payments and bank accounts without traditional banking. I wrote in 2023 that crypto “to some extent started as a backlash to fractional reserve banking and the shadow banking crisis of 2008, and by last year had matured to the point that it recreated both fractional reserve banking (but without regulation!) and a 2008-style shadow banking crisis.” But that is just the beginning of the story. Perhaps the future is that crypto will fully recreate normal banking, including bank regulation.

The MicroStrategy trade is: You take a pot of Bitcoins, you wrap them up in the form of a US public company, and you sell shares in the company for more than the underlying Bitcoins are worth. Put a $100 pot of Bitcoins in a public company that does nothing else, and the company will be worth $200. So you can sell another $100 of shares, buy $100 of Bitcoins, and the company will be worth $400, etc., in a perpetual motion machine.

This has worked surprisingly durably for MicroStrategy Inc. (now called just “Strategy”), which invented the trade. So naturally there are imitators. You can try to replicate it exactly — buy Bitcoin in a US public company — and some companies do, but MicroStrategy has a big first-mover advantage and it’s not clear why anyone wanting Bitcoin in a US public company wrapper would buy a competitor. But you could imitate the trade with some distinguishing twist. Do it in a Japanese public-company wrapper, for instance. (This is the MetaPlanet trade.) Or, instead of Bitcoin, do it with some other crypto asset; there are Ethereum and Dogecoin versions. 

This trade is obviously appealing to some US (and non-US) public companies, but the pure form of the trade probably isn’t that appealing to that many companies. Most companies want to do, you know, the business that they are doing, not just a crypto arbitrage; even MicroStrategy still has a software business. If you run a biotech company working on a cure for cancer, and you realize “hey we could make more money just selling stock to buy crypto,” you might not do it, because you would rather cure cancer. (And because you have no particular talent for buying crypto.) 

On the other hand, if you are a crypto asset manager, this trade is even more obviously appealing: You would rather have investors give you $2 to manage $1 of crypto than have them give you $1. Buying cryptocurrency, and charging investors more than the value of that cryptocurrency, is much closer to the core business of a crypto asset manager than it is to the core business of a software company, so any crypto asset manager should want to do this trade.

But the trade probably only works for a non-financial public company, not for a crypto asset manager. If you’re a crypto manager and you launch a publicly traded crypto fund, it will probably be called a “fund,” and it probably won’t trade at a big premium. (That used to happen, but now crypto exchange-traded funds exist, and it’s harder to launch a crypto fund at a premium.) 

So if you are a crypto asset manager, how do you access this trade? The answer is: You buy a very small US public company and convert it into a pot of crypto, so you can sell shares at a premium. By “buy,” here, I mean not “acquire 100% of the shares and take it private,” but rather “buy new shares of the company for cash to give you control of the company, put all the money into crypto, and then sell more shares.” [1]

That is apparently the Upexi trade:

Upexi Inc. is raising $100 million as part of a pivot that will see the company start to accumulate the cryptocurrency Solana, according to a Monday statement. The company’s shares surged more than 300% in early trading.

Upexi, which had a $3 million market capitalization as of the close of trading last week, announced it has entered into agreements with investors to buy about 43.9 million shares of its common stock, or pre-funded warrants, in a private placement at a price of $2.28 per share. The closing of the offering is expected on April 24.

GSR, a crypto trading and investment firm, is leading the investment and said its involvement underscores the firm’s confidence in Solana as a leading high-performance blockchain.

Here is Upexi’s filing. The stock closed at $2.27 per share last week, [2] and the new $100 million private raise from GSR and friends — representing about 97% of the company — was done at $2.28 per share. The stock traded at about $18.37 per share at noon today, representing roughly an $830 million market capitalization for, I think it is fair to say, a $100 million pot of plans to buy Solana. If you can buy $100 million of Solana and sell it for $830 million, you should.

The filing adds that “it is a condition to the closing of the Offering that the Company enter into an Asset Management Agreement with GSR Markets UK Limited (‘GSR’) whereby GSR will manage the funds for the establishment of the Company’s Solana treasury operations and accumulation of Solana.” That is: GSR and its co-investors have put $100 million into Upexi, and Upexi has put that $100 million into a pot and handed the pot back to GSR to buy Solana, and that pot is now worth $830 million on the stock market. GSR has found a way to launch a Solana fund inside a public company and sell it at a large premium.

One destabilizing fact about the rise of modern artificial intelligence is that it might displace the good jobs, not the bad ones. Automating repetitive manual work is one thing; automating the work of, you know, software engineers or financial columnists is quite another. The pinnacle of AI is of course to automate the work of chief executive officers, particularly CEOs of AI companies. Here’s this guy:

As chief executive officer of the transcription software company Otter.ai, Sam Liang spends a lot of time thinking about meetings. But he’d like to spend less time attending them — at least the non-critical ones — and he’s betting that other CEOs feel the same way.

Enter the “Sam-bot.”

Otter is training an AI-powered avatar on what Liang has said in thousands of meetings and written in documents since he co-founded the company nearly a decade ago. The bot, complete with a voice synthesized to sound like him, is built to handle about 90% of the minutiae and straightforward issues that arise in most business meetings, freeing up Liang to spend more of his time developing new products, wooing potential clients and mentoring colleagues. 

Sure. If the CEO of an AI company is itself an AI bot, what … is … that, exactly? Is that self-replicating AI? AI replicating itself through humans, but the AI tells the humans what to do? I think a lot about the funniest possible ways for robots to destroy humanity, and this is right up there. You go to a routine status meeting at Skynet AI Labs, your boss says “for efficiency I think we should unplug the manual kill switch,” you say “really,” he says “absolutely, do it now or you’re fired,” you do it, and it turns out that your boss was on the golf course and it was his AI avatar who had you remove the last safeguards stopping the your transcription software from enslaving humanity.

Elsewhere: “China’s First Robot Marathon Runners Trip, Emit Smoke, Fall Apart,” which is exactly what I would do if I ran a marathon, so impressive verisimilitude I guess. 

Before my vacation I wrote that:

1. A lot of quite different businesses — quantitative hedge funds, artificial intelligence labs, professional soccer teams — are really the same business (data science), and they employ the same sorts of people (astrophysics PhDs).
2. Many of the firms in those businesses impose long periods of “gardening leave,” where if you leave one hedge fund/AI lab/soccer team for another, you have to wait a long time before you start your new job.
3. Those firms really care about this, for competitive and intellectual-property-preservation reasons, but it seems socially wasteful to have all those astrophysics PhDs not doing anything for a year.
4. There should be some sort of exchange program, a gap year where the hedge fund quants can’t start at a new hedge fund for a year, but they can go work for a soccer team while they wait. And vice versa, etc.

I got a number of good emails about this, including one from an astrophysicist saying “now what I need to do is convince them to pay my lab a few dollars for the privilege of working with us during their leave.” Another reader pointed out that the whole notion of open source software runs to some extent on this basis: A lot of software engineers at fancy companies are either underemployed or on gardening leave, so they build open source tools until they start a new job. Another reader pointed out that there are a lot of nonprofits that could benefit from a year’s skilled work by a data scientist being paid by her former hedge fund/AI lab/soccer team.

But also a reader pointed out that some literal version of this exists. Some hedge funds, at least, have more or less explicit gap-year programs for new hires waiting out their gardening leaves. Here’s a Business Insider article from last year about Citadel:

A new program from billionaire Ken Griffin's firms partners with its philanthropic arm to keep new hires engaged. The Impact Fellows program was piloted last year with 12 new hires, who worked for no pay with one of Citadel's nonprofit partners on different projects.

Employees were matched with a nonprofit based on their interests and technical abilities, said Julia Quinn, Citadel's head of philanthropy. The voluntary program is now embedded in the recruiting process for the firms, she said, meaning offers to potential hires mention it — one of the reasons she is "cautiously optimistic" that the number of participants will increase in the program. ...

The employees who participated appreciated just having something engaging to do. Jimmy Huang, systematic trader at Citadel Securities, had an 18-month garden leave that felt "like a weekend every day." He tried to keep his data science skills sharp with free videos and online competitions, but his time with education nonprofit Schoolhouse.world — where he worked roughly 20 hours a week and had regular meetings — was more his speed.

I suppose it is nice that it focuses on philanthropic uses of their time, though I think they should be allowed to run soccer teams too.

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