Let me tell you a story. This story begins in 2020, a few months into the COVID-19 pandemic. There was a new NFT company in town — the Treasure project — and they had a really intense utility concept. The Treasure team created a genesis NFT collection that featured something very attractive: a guaranteed 15% yield annually for the next 10 years. If you bought one of their utility NFTs for $10,000, you’d receive $1,500 a year for the next 10 years. Even better, at the end of those 10 years, you could trade the NFT back to them and they’d return the $10,000 you originally paid for it.
The team behind Treasure was well-known and well-respected, so when their sales team went out and started offering whitelist spots to all the big guilds, there was a lot of interest. The guild leaders started pooling their community members’ money, so they could buy as many NFTs as possible. The NFTs were pretty expensive, but that was ok, because it was a great deal. When the genesis collection was released, it completely sold out. A resounding success! And for the next year, the guilds holding the Treasure NFTs earned their 15% yield as expected.
Then 2022 came along, and with it, crypto winter. A rough year, by any definition. The Treasure project team realized that they needed to raise more money. What should they do? Well, their entire genesis collection was already sold out, so they needed something else to sell. What they eventually came up with was a Generation 2 collection. Unfortunately, the new set was all the same designs which ordinarily wouldn’t be very interesting to the market. So to make things more exciting, Treasure increased the yield on this new collection. Instead of 15% per year, the holders of the Gen-2 NFTs would receive 50% yield! This was an amazing deal … for everyone except the guilds who bought the genesis NFTs. Why? Well, the market knew they could get a better yield with the Gen-2 NFTs, so suddenly the genesis pieces weren’t very attractive anymore. That kinda sucked, but the guild leaders were at least comforted by the fact that in 8 more years, they’d be able to sell those less-valuable NFTs back to the Treasure team. They’d get their original money back, even though they missed out on the higher yields of Gen-2.
But in 2023, things got nasty. The individual members of the guilds realized that the Gen-2 NFTs weren’t just a little better, they were 300% better. A few of them went to their guild leaders and told them that they wanted to take their money out of the guild pool. They wanted to buy those Gen-2 NFTs directly and earn all the yield for themselves, and this was, of course, totally within their rights to do. But their money wasn’t there — it was all invested in the genesis NFTs! The guild was liable for their members’ funds, so in order to return their money, the guild leaders had to do the one thing they really didn’t want to do. They had to sell the Treasure genesis NFTs on Opensea, and as expected, these less valuable NFTs only fetched 75% of the original price. It was a terrible situation all around, as the rest of the guild realized that if they all asked for their money back at that moment, there would only be enough to cover 75% of the members. Suddenly, it was every man for himself! Each member raced to ask for their money so they wouldn't be one of the 25% left empty-handed. Although they tried, the guild leaders couldn’t fix the problem and they eventually had to own up to the fact that they’d lost some of their community’s money.
By now you’ve probably figured out my little allegory, but let me unpack everything anyway. In this allegory, the “Treasure project” is the United States Treasury, and the “guilds” are the banks. In 2020, the Treasury sold Treasury bonds (not NFTs, obviously) to the banks with an interest rate of 1.75%. The banks would receive 1.75% in interest every year that they held those bonds. Over $1T of these types of bonds were sold. However, in 2022, interest rates increased like crazy, so there was now a new “generation” of bonds that had yields of 5%+. Unfortunately, the banks were still stuck holding the old stuff, which wasn’t ideal, but was still technically alright. They weren’t worthless, they were just worth less than the new stuff. Remember that after 10 years, those bonds could be returned in exchange for their original purchase price, so all the banks had to do was hold them until then.
However, in March 2023, something unexpected happened. A few people started to notice that banks were sitting on a lot of assets — those old bonds — that weren’t worth as much as they used to. The news spread, and a whole bunch of depositors started to withdraw their money, fearing instability. And because banks don’t keep a lot of cash on hand (in the US, they aren’t even legally required to keep any reserves at all) they were forced to do the one thing they didn’t want to do. They had to sell those old bonds. And since those bonds were worth so much less, the banks came up short. They couldn’t return all of their customers’ money. This is basically what happened to Silvergate and Silicon Valley Bank this month. It was a classic bank run.
The full story is a lot more complicated than that, but the general idea is all there. The rising interest rates in 2022 caused old bonds to be less valuable, and when depositors started withdrawing their funds, the banks were forced to “realize those losses.” This whole story is part of a much more complex fabric: the Federal Reserve wasn’t just raising interest rates on whim, they were doing it to curb inflation. But monetary policy is an imprecise tool, and often has unpredictable consequences. In this case, the consequence was the collapse of at least two US banks. (The reason for Signature’s demise is a bit murkier.)
What happens next? Well, since it was largely the Fed’s interest rate hikes that caused this chaos, they need to be the ones to clean it up. The solution is their Bank Term Funding Program (BTFP), which will lend money to troubled banks. The loan amount will be up to 100% of the bank’s assets, meaning that even if every depositor withdrew every dollar in that bank, the Federal Reserve would cover it all. Importantly, the BTFP would ignore the current market value of any Treasury bonds that the bank holds, and pretend that they are all worth the original purchase price. This could be the biggest bank bailout we’ve ever seen!
Stay safe out there, cryptofam!
*For the sake of believability, I decided to make the numbers in my allegory (15% and 50%) more in line with 2020 crypto yield rates. The real-life numbers were 1.75% and 5.5%, respectively, but you get the idea ;)
**I wasn’t really sure when I was writing this allegory whether it’d make things clearer to the average crypto person, but it occurred to me that a lot of my readers probably understand “utility NFTs” and “yield” more than “bonds” and “interest rates.” If you found this useful, please let me know in the comments!
The end of fiat is nigh.
"...a lot of my readers probably understand “utility NFTs” and “yield” more than “bonds” and “interest rates.” "