6 ms·

(Not necessarily on-topic, but highly-relevant and educational!) For anyone interested in understanding the dynamics behind bank runs, the Diamond–Dybvig model

by narush 4y ago

(Not necessarily on-topic, but highly-relevant and educational!) For anyone interested in understanding the dynamics behind bank runs, the Diamond–Dybvig model [1] is worth reading. It describes a very simplified situation where due to banks short-term liabilities and long-term assets, a bank run is a valid Nash equilibrium. I think they won a Nobel prize for this model. There’s also some very interesting discussion at the end about preventing runs: first if banks can suspend withdrawals, and second through central bank backing. I’ll avoid summarizing it because I’m too dumb — but to quote: “Deposit insurance provided by the government allows bank contracts that can dominate the best that can be offered without insurance and never do worse.” [1] https://www.bu.edu/econ/files/2012/01/DD83jpe.pdf https://www.bu.edu/econ/files/2012/01/DD83jpe.pdf

panphora 4y ago
The problem with suspending withdrawals for crypto firms is the market interprets it as your exchange is insolvent (as that has usually been the case so far). This will crash markets (lowering your liquidity even more) and make people want to withdraw even more once you reopen. The situation is made worse because a lot of exchanges issue their own token: CRO in Crypto.com's case. This token provides extra liquidity to your exchange, sometimes in the billions (on paper at least), that you can borrow against. The moment you mention pausing withdrawals, your custom token will crash to the ground and you'll lose a lot of potential liquidity (See Terra/LUNA & FTC/FTT).
- dragontamer 4y ago
  CRO crashed yesterday. Crypto.com's ability to raise money from CRO is much much less, and possibly non-existant now...
- dragonwriter 4y ago
  > The problem with suspending withdrawals for crypto firms is the market interprets it as your exchange is insolvent That’s a problem with suspending withdrawals, especially by individual institutions, generally, I think, which is one reason why government deposit insurance is the better solution, in practice. Even the 1933 Bank Holiday in the US, a government-declared suspension of banking, probably only succeeded because the government established temporary emergency deposit insurance during the break.
- pjc50 4y ago
  > issue their own token: CRO in Crypto.com's case. This token provides extra liquidity to your exchange Yeah, this is where the fraud happens. They're treating the token like a bond when it's just .. a made-up thing? It's not a promise to pay, it doesn't have a claim on anything, it doesn't buy you votes, it's just a shiny Pog that you can trade? This would be like a casino claiming its chips as assets.
  - jasonwatkinspdx 4y ago
    > This would be like a casino claiming its chips as assets. This phrasing is a great way to get the idea across.
  - Bud 4y ago
- matheusmoreira 4y ago
  > The problem with suspending withdrawals for crypto firms is the market interprets it as your exchange is insolvent As it should. Inability to withdraw obviously means they don't have the money. Any limits on withdrawals are and should be major red flags. Exchanges should be punished by the market every single time they pull stunts like that until they learn the lesson.
  - notahacker 4y ago
    And to underline the difference: suspending withdrawals can allow a bank's customers to [eventually] get their money back when the bank's creditors get repaid. And the bank never pretended it wasn't making loans in the first place. If a crypto exchange suspend withdrawals, on the other hand, there's no reason to suspect they're just waiting on a bunch of loans to ordinary people and businesses to come in, especially since it usually means they lied about custody of assets.
    - kasey_junk 4y ago
      Clarification: depositors are considered a banks senior creditors. They get paid before the other creditors. The reason a bank would suspend withdrawals is so it can be either taken over in an orderly fashion (in the US supervised by the FDIC) or so they can get a liquidity infusion (in the US, depending on their charter, from the fed). Those regulatory agencies and bankruptcy rules don’t exist for a crypto exchange so there is very little an exchange can be doing when suspending withdrawals that doesn’t end with the exchange going bust.
  - lupire 4y ago
    You can't "punish a market" after everyone stopped putting money in and started taking money out.
gst 4y ago
> There’s also some very interesting discussion at the end about preventing runs: first if banks can suspend withdrawals, and second through central bank backing. I’ll avoid summarizing it because I’m too dumb — but to quote: “Deposit insurance provided by the government allows bank contracts that can dominate the best that can be offered without insurance and never do worse.” The simplest approach for crypto exchanges to prevent bank runs would be to not lend out or trade with deposits. In fact, that's what some exchanges have always been doing (or at least are claiming to do).
- dragontamer 4y ago
  > The simplest approach for crypto exchanges to prevent bank runs would be to not lend out or trade with deposits. Except the consumer is drawn to the crypto-exchanges with significant "staking" rewards. Like Crypto.com or FTX. When you're promising free money, you can't just sit on the money. You gotta lend it out to generate those staking rewards. Now maybe, just _maybe_, the lending out of customer deposits could be a tightly regulated activity. Maybe regulations upon the types of securities that you lend to (ie: to AAA rated corporates), as well as maturity (ex: 1-week expiration or daily expiration). Oh wait, that's a Money Market Fund. Add on FDIC insurance and you're now at a federally regulated savings account.
  - gst 4y ago
    > Except the consumer is drawn to the crypto-exchanges with significant "staking" rewards. Like Crypto.com or FTX. Staking itself wouldn't be a problem. There would be some risk involved in case of technical problems (for example due to Slashing on Ethereum), but in overall that risk should be relatively small. Exchanges could still hold all of the coins, but just use some of the coins for staking (if users owning the coins opt-in to staking). The problem occurs when exchanges lend out stored coins without the approval of the user: Either to lend them for shorting or to invest them into something that they assume would appreciate faster.
    - pjc50 4y ago
      Staking is a problem because it pretends to offer risk-free returns while investing in extremely risky assets. Or just straight up fraud. None of the staking schemes have adequately explained who's taking the other side of the trade. Who wants to borrow a token for a very high interest rate? So far the only examples are "people putting it into an even bigger fraud" and "people providing soon-to-be-worthless collateral".
runeks 4y ago
> It describes a very simplified situation where due to banks short-term liabilities and long-term assets, a bank run is a valid Nash equilibrium. > There’s also some very interesting discussion at the end about preventing runs: [...] Did they not consider matching liability and asset duration as a solution?
- rich_sasha 4y ago
  For banks this often just isn't an option. If nothing else, the core business of the bank is about borrowing cheaply (hence short term) and making risky, long term loans (hence bringing in interest). If they want to finance the loans by long term loans themselves, much of the profit goes away and the business isn't sustainable. It's obviously a sliding scale but that's the starting point.
  - lupire 4y ago
    Banks get most of their capital from equity, which is an infinite-term. Short term loans have higher interest rate, usually, but have transaction fees.
  - runeks 4y ago
    Well, profit can always be increased by increasing risk. So the question is whether the additional risk incurred due to duration mismatch is worth the increase in profits. It's obviously worth it to the bank's shareholders if the bank is bailed out by tax payers when things go wrong. But if there's no bailout it may not be worth it for them -- at least not in the long run.
- pjc50 4y ago
  > Did they not consider matching liability and asset duration as a solution? People would not be keen on 30 year notice deposit accounts to match 30 year mortgages.
  - lupire 4y ago
    But multi-year CD ladders are common, which can provide a runway for adjusting risk.
tarsinge 4y ago
The problem is, Crypto exchanges advertise themeselves as brokers. Bank run should simply not be possible: customers money/crypto should be "there” in the first place and not having be reinvested behind customer’s back. The panick is because delays kind of prove an exchange is fraudulent and the money is potentially gone if the exchanges investments have gone south, simple as that, no need for complex models.
- deleted 4y ago
  [deleted]
- zarzavat 4y ago
  Delays don’t prove an exchange is fraudulent. Small delays happen legitimately due to the hot wallet becoming empty during a period of greater than expected withdrawals. In a period of normalcy, these small delays are forgotten. However users are extremely nervous right now. Users can interpret small delays as insolvency, which causes a torrent of withdrawals which take even longer to process. I don’t know if crypto.com is solvent. If you have money on there, you should probably get it out now. But there is also an innocent explanation to all of this.
  - lupire 4y ago
    Crypto.com is a known bad actor, gliding on the dwindling benefit of the doubt. They'be had years to demonstrate a reputation for innocence.
  - naijaboiler 4y ago
    believe this at your own peril.
RugnirViking 4y ago
to be specific, it won the "Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 2022". It's not affiliated with the nobel prize most people know. I don't intent this as a dig at economics; there is no Nobel prize for mathematics either. Though I have my doubts about the rigorousness of some economic research, we all stand to benefit from better economics
- Tomte 4y ago
  Not affiliated with the Nobel Prize, except… the Nobel Prize website lists it. I guess nobody cares about message forum well-actuallys, least of all the Nobel Prize itself.

by narush 4y ago

panphora 4y ago

The problem with suspending withdrawals for crypto firms is the market interprets it as your exchange is insolvent (as that has usually been the case so far). This will crash markets (lowering your liquidity even more) and make people want to withdraw even more once you reopen. The situation is made worse because a lot of exchanges issue their own token: CRO in Crypto.com's case. This token provides extra liquidity to your exchange, sometimes in the billions (on paper at least), that you can borrow against. The moment you mention pausing withdrawals, your custom token will crash to the ground and you'll lose a lot of potential liquidity (See Terra/LUNA & FTC/FTT).

dragontamer 4y ago
CRO crashed yesterday. Crypto.com's ability to raise money from CRO is much much less, and possibly non-existant now...
dragonwriter 4y ago
> The problem with suspending withdrawals for crypto firms is the market interprets it as your exchange is insolvent That’s a problem with suspending withdrawals, especially by individual institutions, generally, I think, which is one reason why government deposit insurance is the better solution, in practice. Even the 1933 Bank Holiday in the US, a government-declared suspension of banking, probably only succeeded because the government established temporary emergency deposit insurance during the break.
pjc50 4y ago
> issue their own token: CRO in Crypto.com's case. This token provides extra liquidity to your exchange Yeah, this is where the fraud happens. They're treating the token like a bond when it's just .. a made-up thing? It's not a promise to pay, it doesn't have a claim on anything, it doesn't buy you votes, it's just a shiny Pog that you can trade? This would be like a casino claiming its chips as assets.
- jasonwatkinspdx 4y ago
  > This would be like a casino claiming its chips as assets. This phrasing is a great way to get the idea across.
- Bud 4y ago
matheusmoreira 4y ago
> The problem with suspending withdrawals for crypto firms is the market interprets it as your exchange is insolvent As it should. Inability to withdraw obviously means they don't have the money. Any limits on withdrawals are and should be major red flags. Exchanges should be punished by the market every single time they pull stunts like that until they learn the lesson.
- notahacker 4y ago
  And to underline the difference: suspending withdrawals can allow a bank's customers to [eventually] get their money back when the bank's creditors get repaid. And the bank never pretended it wasn't making loans in the first place. If a crypto exchange suspend withdrawals, on the other hand, there's no reason to suspect they're just waiting on a bunch of loans to ordinary people and businesses to come in, especially since it usually means they lied about custody of assets.
  - kasey_junk 4y ago
    Clarification: depositors are considered a banks senior creditors. They get paid before the other creditors. The reason a bank would suspend withdrawals is so it can be either taken over in an orderly fashion (in the US supervised by the FDIC) or so they can get a liquidity infusion (in the US, depending on their charter, from the fed). Those regulatory agencies and bankruptcy rules don’t exist for a crypto exchange so there is very little an exchange can be doing when suspending withdrawals that doesn’t end with the exchange going bust.
- lupire 4y ago
  You can't "punish a market" after everyone stopped putting money in and started taking money out.

gst 4y ago

> There’s also some very interesting discussion at the end about preventing runs: first if banks can suspend withdrawals, and second through central bank backing. I’ll avoid summarizing it because I’m too dumb — but to quote: “Deposit insurance provided by the government allows bank contracts that can dominate the best that can be offered without insurance and never do worse.” The simplest approach for crypto exchanges to prevent bank runs would be to not lend out or trade with deposits. In fact, that's what some exchanges have always been doing (or at least are claiming to do).

dragontamer 4y ago
> The simplest approach for crypto exchanges to prevent bank runs would be to not lend out or trade with deposits. Except the consumer is drawn to the crypto-exchanges with significant "staking" rewards. Like Crypto.com or FTX. When you're promising free money, you can't just sit on the money. You gotta lend it out to generate those staking rewards. Now maybe, just _maybe_, the lending out of customer deposits could be a tightly regulated activity. Maybe regulations upon the types of securities that you lend to (ie: to AAA rated corporates), as well as maturity (ex: 1-week expiration or daily expiration). Oh wait, that's a Money Market Fund. Add on FDIC insurance and you're now at a federally regulated savings account.
- gst 4y ago
  > Except the consumer is drawn to the crypto-exchanges with significant "staking" rewards. Like Crypto.com or FTX. Staking itself wouldn't be a problem. There would be some risk involved in case of technical problems (for example due to Slashing on Ethereum), but in overall that risk should be relatively small. Exchanges could still hold all of the coins, but just use some of the coins for staking (if users owning the coins opt-in to staking). The problem occurs when exchanges lend out stored coins without the approval of the user: Either to lend them for shorting or to invest them into something that they assume would appreciate faster.
  - pjc50 4y ago
    Staking is a problem because it pretends to offer risk-free returns while investing in extremely risky assets. Or just straight up fraud. None of the staking schemes have adequately explained who's taking the other side of the trade. Who wants to borrow a token for a very high interest rate? So far the only examples are "people putting it into an even bigger fraud" and "people providing soon-to-be-worthless collateral".

runeks 4y ago

> It describes a very simplified situation where due to banks short-term liabilities and long-term assets, a bank run is a valid Nash equilibrium. > There’s also some very interesting discussion at the end about preventing runs: [...] Did they not consider matching liability and asset duration as a solution?

rich_sasha 4y ago
For banks this often just isn't an option. If nothing else, the core business of the bank is about borrowing cheaply (hence short term) and making risky, long term loans (hence bringing in interest). If they want to finance the loans by long term loans themselves, much of the profit goes away and the business isn't sustainable. It's obviously a sliding scale but that's the starting point.
- lupire 4y ago
  Banks get most of their capital from equity, which is an infinite-term. Short term loans have higher interest rate, usually, but have transaction fees.
- runeks 4y ago
  Well, profit can always be increased by increasing risk. So the question is whether the additional risk incurred due to duration mismatch is worth the increase in profits. It's obviously worth it to the bank's shareholders if the bank is bailed out by tax payers when things go wrong. But if there's no bailout it may not be worth it for them -- at least not in the long run.
pjc50 4y ago
> Did they not consider matching liability and asset duration as a solution? People would not be keen on 30 year notice deposit accounts to match 30 year mortgages.
- lupire 4y ago
  But multi-year CD ladders are common, which can provide a runway for adjusting risk.

tarsinge 4y ago

The problem is, Crypto exchanges advertise themeselves as brokers. Bank run should simply not be possible: customers money/crypto should be "there” in the first place and not having be reinvested behind customer’s back. The panick is because delays kind of prove an exchange is fraudulent and the money is potentially gone if the exchanges investments have gone south, simple as that, no need for complex models.

deleted 4y ago
[deleted]
zarzavat 4y ago
Delays don’t prove an exchange is fraudulent. Small delays happen legitimately due to the hot wallet becoming empty during a period of greater than expected withdrawals. In a period of normalcy, these small delays are forgotten. However users are extremely nervous right now. Users can interpret small delays as insolvency, which causes a torrent of withdrawals which take even longer to process. I don’t know if crypto.com is solvent. If you have money on there, you should probably get it out now. But there is also an innocent explanation to all of this.
- lupire 4y ago
  Crypto.com is a known bad actor, gliding on the dwindling benefit of the doubt. They'be had years to demonstrate a reputation for innocence.
- naijaboiler 4y ago
  believe this at your own peril.

RugnirViking 4y ago

to be specific, it won the "Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 2022". It's not affiliated with the nobel prize most people know. I don't intent this as a dig at economics; there is no Nobel prize for mathematics either. Though I have my doubts about the rigorousness of some economic research, we all stand to benefit from better economics

Tomte 4y ago
Not affiliated with the Nobel Prize, except… the Nobel Prize website lists it. I guess nobody cares about message forum well-actuallys, least of all the Nobel Prize itself.