Governments criticize cryptos for being opaque – and unregulated.
You might be surprised to know that the largest market on earth isn’t government bonds or even FOREX. It is Over The Counter (OTC) derivatives. And it is almost totally unregulated.
Anyone remember the global financial crisis in 2008?
What many call Mortgage Backed Securities (MBSs) are actually a hybrid form of derivative security. The “mortgage bonds” Wall St. et al. cooked up back then derived their value from home loans.
Using advanced math and corrupt business practices, the banks were able to package the loans in something that appeared to be a bond – and the rating agencies went along with the con.
The market for these MBSs was global – and it was the big players holding the bag. There weren’t many mom and pops holding the junk – most retail investors can’t access the derivative market.
And the derivative market – not the 2008 GFC – is what matters today.
Modern Financial Regulatory Nonsense
As of this morning, the entire crypto complex is worth less than $2.5 trillion USD. Much like the equity market, cryptos are easy to value. Loads of free websites will tell you what cryptos are worth in real time.
The derivatives market isn’t as easy to value. In fact, we don’t really know what it is worth at any given moment – or the nature of the offsetting contracts. It was estimated to be worth nearly $670 trillion by the end of last year by the BIS – which is a striking figure.
With such a large market – one would think that it would be strictly regulated. One would be wrong.
Bank-to-bank OTC derivative transactions aren’t subject to much oversight. There are some reporting requirements, but risk analysis is nearly impossible. The market is global, and money center banks run the whole show. In essence – the players are above the law.
On-Chain Transparency
Decentralized blockchains create global transparency in a way that would have been impossible 20 years ago. Now, people and organizations anywhere with internet access can example any transactions they like on public blockchains.
You want to inspect Ethereum transactions?
No problem – access is free and open to anyone.
Dr. Yener Coskun thinks blockchains like Ethereum are a solution to transparency problems in the derivatives market. In his ”The Limitations of Transparency Policy in OTC Markets and Derivatives Trading” paper, he states that a decentralized ledger’s “trust-free transactions” would “contribute to market efficiency and risk management”
While Bitcoin’s blockchain might be a little clunky to use for global derivatives trading, ETH, XRP, SOL, ADA and others would be ok. There is no way the banks would ever go for it – in the same way they are turning tokens into assets – not money.
Let’s Talk Risk…
Remember that figure of nearly $670 trillion in derivatives?
There simply isn’t that much money in the world. Measuring money is kinda a weird activity anyway, as most large investors hold bonds – as they prefer to have governments as counterparties.
If you just have to have a figure – some estimates say there is around $20 trillion out there in cash and cash equivalents. This figure is open to argument.
The point – is that no matter how you measure the amount of money there is – the pile of derivatives we have is far larger.
The World Bank estimated Global GDP to be around $115 trillion in 2023 – so that shows you how strikingly large the derivatives market grew by the end of 2023.
Oh yes – risk. The risk in this situation is that something bad happens – and banks need to make good on the derivatives contracts they created.
Why Aren’t Derivatives Regulated?
A common misconception is that banks don’t like regulation. It’s only partially true. When you understand the part that is true – you will understand why cryptos are taking so much heat from regulators – and why the derivatives market is almost totally unregulated.
Banks want regulations that keep small players out. There is a reason why the USA – a nation of more than 330 million people – has only 4 major banks. The big players like to have control over the market – investors love a monopoly.
On the other hand – banks want as little interference as possible when it comes to how they do business. Once you are in the club – anything goes.
Regulators like the European Union’s Directorate-General for Financial Stability, Financial Services, and Capital Markets Union tried to tackle the derivatives issue recently. It didn’t work. You shouldn’t be surprised considering other regulators have tried and failed for decades.
The game is rigged – and the game is dangerous.
But Wait – It Gets Worse
Derivative contracts aren’t debts – they are far more like insurance contracts. As you may have noticed, the world is looking more unstable every day. While global instability comes and goes over centuries, the existence of a derivatives market that is nearly six times the size of the global economy is something new.
While derivatives can be written on anything, most are created for FOREX, bonds and equities. The number of potential crisis points that exist are infinite – but if any one of them manifests – the markets would implode.
Example: war in the Middle East goes wild and everyone gets in on the horror. Global currencies melt down. We have no idea what it would do to FOREX, equity, and government bond markets – but it would be serious.
In that kind of situation – the derivatives market would react. We have no idea what kind of hole would need to be filled on bank balance sheets – but it would be huge.
The Blockchain Panopticon
Blockchain would be a great way to limit risk in the OTC derivatives market – but the banks have other ideas. Instead of using decentralization to create stable systems, governments and banks want to use blockchain to control the serfs.
But no. Blockchain will be used to roll out a system that tracks purchases, and limits buying options.
In fact, today’s stablecoins could be tomorrow’s dystopian control tools. China already has a social credit score, and a fledgling CBDC. These systems can easily be used anywhere – as the CBDC debacle in Nigeria demonstrates.
The permutations that a CBDC control grid may take are limitless. But the money will no longer be yours in any way. Transparency for the serfs, total opacity for the ruling class. Once a two-tired system is in place, it will be hellish to remove.
A Part of The Next Problem
Despite its enormous size, the derivatives market remains largely hidden from public view.
Now you know why.
Not only do the majority of trades occur OTC – away from centralized exchanges and regulatory oversight – but the very nature of these transactions often obscures information. Even if you could access a record of the trades – you would have no idea of a bank’s actual exposure.
Trading OTC derivatives on a public blockchain could help, but the banks will never let it happen. They want secrecy for their own transactions, and total transparency for yours.
Welcome to neo-serfdom in the digital age.
