Either experience makes these concepts possible, or these concepts make experience possible.

Understanding Liquidity


What is liquidity? Why is it important? Where does it come from, and where is it going?

Liquidity is the ability to realize a value transfer (payment) in full right now. This is important because it allows us to do things. Modern currency is based on commercial bank loans lending money into existence, the deference of liquidity by making a longer-term loan actually creates liquidity for the borrower, who invests the money in a business or a house or maybe (in the case of credit cards) just a couple of movie tickets and a pack of Cheez Doodles. 

The liquidity of a banking system is backed by “power money”, some reserve asset that is scarce and used as the margin foundation for the whole game of musical chairs that we call capitalist society (the degree that it’s really capitalist is about to be explored): In the United States that reserve used to be gold, but Nixon put a stop to that so the US could simulteanously spend new dollars and keep its gold. Now the reserve asset are treasury bonds issued successfully because a) everyone else is scared/impressed enough by the US’s power that they think the bonds are a “risk-free” investment and b) failing that, the Fed will buy them with freshly typed USD created out of thin air. 

Every other national government would love to pull this off in the same way that every Sorority Girl would love to party like Paris Hilton, but Paris just had that brand-name ubiquity, and most importantly, she is substantially more liquid than your average Kappa Gamma pledge. Argentina, by counter-point, is the Sorority Girl who tries to live like Paris, went into substantial debt doing so, and now gets by evading creditors and convincing boyfriends to buy her things. If Argentina could get away with money printing the way the US does, they probably would have invaded Paraguay and Bolivia by now, seizing what’s under the ground there in the name of “dominancia de espectrum lleno”, history had a different proscription.

Now let’s look at China, still very much a communist country, doing capitalism in a fashion after Lenin’s own designs, and until recently, prohibiting banks anyone from defaulting. They were able to keep this march going by accumulating “power money” in the form of US T-bonds (and as much gold as they can get their hands on) and by managing the exchange rate of their currency to keep the exporting cashflow alive. Coupled with capital controls, which gives cryptocurrency a huge value for mainland investors, the Chinese Yuan is simultaneously one of the world’s most liquid currencies and also, funny money. It is the funniest liquid currency around, where it is funny is where that liquidity is censored by authorities. Argentina’s peso is a lot funnier, it makes the Yuan look like Gallager while it is closer to Louis CK in its dry irony (the largest denominated bill is worth about $9 USD, other denominations are useful only as change), but nobody is structuring bi-lateral trade deals around the peso. 

In the US, the money creation is explicitly fake, but with a sort of seriousness that makes most of the population (brainwashed to a degree only surpassed by China and North Korea) accept its “king” status among currencies. In China, the money creation is explicitly based on accumulating hard assets, but in practice is less stable than the USD, depending on a manufactured stability. As Quantitative Easing comes to envelop the majority of t-bond purchases, the different will be harder to tell. 

USD and CNY trading for cryptocurrency provides the basis for the utility of this technology in evading the goofy capital controls of China and annoying lite-capital controls of the US (implied by the onerous bank regulations that have pre-empted easy transfer of USD deposits to an exchange, only Coinbase exists as an exit, and it is a cumbersome one). Knowing that these mammoth engines for liquidity are based on a geo-political dance predicated by false promises that seem legit based on the margins of global trade, one has to wonder about the future of liquidity. 

Shadow banking is the biggest source of liquidity in the world, existing on the regulatory fringes of these controlled fountains of liquidity, they extend it to its logical extremes. In China this exists in the form of high-interest loans collateralized by warehouses full of copper, and in the US this exists in the derivatives markets,  collateralized often by other derivatives, most significantly related to interest rates, which are controlled by the base of the Federal Reserve buying t-bonds at prices that wouldn’t be sustainable without QE. 

This is what cryptocurrency is competing with. 

Capital stock tokens like BTC and LTC provide the power money base for this young alternative shadow financial system, soon derived instruments with more distributed and transparent counter-party risk will come about to take the early liquidity and give it lots of options about what to do. Creating credit in a peer-to-peer way with leveraged escrow bets and perhaps reputation-based debit limits for tokens with dynamic money supply, are future steps. For the foreseeable future, this system will be dependent on the supply of fiat money from the dominant political economies, but the foreseeable future in this space is about 6 weeks.

By investing or trading crypto, and by taking that crypto and plugging it into other secondary markets, you are contributing to a more decentralized alternative.