Few take the time to consider the liability tied to money. When most engage in a financial transaction, they rarely think about the vulnerability related to the counterparty. Instead, they simply go ahead with the transaction presuming everything is golden.
Cryptocurrency is teaching some a lesson. Sadly, most seem to be missing it, that is why it is not everyone being taught. This is something that is imperative going forward. It is also why we can be sure that the Hive Backed Dollar (HBD) stands out.
Double entry accounting tells us that for every asset there must be a liability. Hence, regardless of the transaction, if we have an asset on our balance sheet, there has to be a liability somewhere else. This is the case with money.
Here is where we define the risk associated with everything we do. Those who fail to do this are realizing how vulnerable they truly are. Counterparty risk is a term that most should familiarize themselves with.
In this article we will go through the different levels of risk associated with money. We will also indulge in the world of cryptocurrency to see where so many are going wrong.
The Baseline
US Treasuries are considered the safest form of investment there is. This is often used as the baseline for all financial risk models. Bonds such as the 10 year Treasury are the "gold standard" when it comes to this type of analysis.
Why are US Treasuries set as risk-free? This boils down to the ability to repay. There never was a default on any Treasury securities. When looking at the banking and financial arena, confidence is the entire story.
As we discussed, US Treasuries are the only form of high quality and pristine collateral in the wholesale banking system. For this reason, the debt always gets sold. Here is another reason why these models use these assets as the baseline. The demand means that no matter how much spending the US Government does, the securities are purchased.
Thus, anyone who buys a US Treasury is in the safest asset there is.
How does this compare to just putting money in the bank?
To answer this question, we have to look at how solvent the bank truly is. By delving into the balance sheet, we can determine if our bank will fail or not. If the numbers are bad, obviously our money is at risk.
In this developed world, this is not the case. Before the Great Depression, in the United States, it certainly was true. However, the Bank Act of 1933 introduced the FDIC to the world. This provides insurance on deposits in American banks up to the amount of $250K.
Hence, is someone puts money in a saving account, the counterparty risk is near zero up to that limit. After that, the deposit is at risk if the bank should fail.
This is obviously not as strong as a Treasury but is almost risk free.
One thing to keep in mind, when you make a deposit to a bank, that is an asset on your balance sheet. It shows up as cash (or cash equivalent) to you. The flip side is the liability the bank now has. Since it is expected that you will want your money back, the bank can presume it owes you whatever is on deposit.
Again, all in line with double entry accounting.
Investment Protection
When investing, how much counterparty risk are we assuming? This is something that is imperative.
Few look at the balance sheet of their brokerage company before deciding to put their money there to trade or invest. The reason for this is because similar protections exist as with the banks. A brokerage account is covered up to a few million before that money is at risk. Hence, when we put $100K with a JP Morgan, we know our money is safe from counterparty exposure. If the investment fails, the account is preserved.
Obviously, many thought this was the case with cryptocurrency. Unfortunately, they are finding out that exchanges in this realm are not the same. Whereas one can go to JP Morgan, even in times of financial stress, and withdraw his or her money, this is not the case with cryptocurrency. People are learning throughout 2022, these liabilities are considered the same as any other. There is no special protection.
What this means is these individuals have to enter the bankruptcy case like any other creditor. It requires getting in line to access the money based upon the rulings of the court. At best, this is going to be a time consuming process; at worst, there will be major losses.
The risk of the investment itself, say buying Bitcoin, is not the only consideration. Instead we also have to consider the risk associated with the solvency (or liquidity) of the entity we are dealing with. Celsius, Mt Gox, and FTX are all lessons in this.
Sadly, it seems like few consider the counterparty risk before making a move.
Hive Backed Dollar
The stablecoin world is also questioning this. We witnessed the implosion of UST as LUNA failed. While many are turned off by algorithmic stablecoins, believing they are inherently risky, the reality is the counterparty risk was there all along.
Many posed the same question about Tether, which is not an algo coin but rather asset backed. Yet, we are dependent upon the word of the company that each token is backed by what they say. There are serious questions with transparency. Circle is in the same situation.
Of course, regulators claim this is why oversight is needed. Circle is taking steps to become compliant. However, as we saw with Enron, accounting scandals do happen. The banks have "cooked the books" for decades, paying fines each time they get caught.
HBD offers a different solution. When we look at the liability that is tied to the asset sitting in your wallet, we see how the measures take reduce the risk associated with holding that coin.
To start, this is a base layer coin. By staking it through the saving account, the counterparty in this instance is the blockchain itself. Hence, the only way it can implode is if the blockchain stops running. As long as someone a node going, the software will be in operation, allowing access to the money.
There is also the Internal Exchange. Here we can trade HBD for $HIVE. Again, this limits the risk to the blockchain only. There is no company or entity that has control over all the accounts. Nobody can come in and shut down the entire exchange or stop trading. As long as people are putting up in orders, the exchange keeps trading.
HBD also have full transparency.
This coin is backed by $1.00 worth of HIVE. Unlike USDC or Tether, there is no USD (or equivalents) backing the coin. Instead, it is fully backed by $HIVE. As long as the haircut rule is avoided, the blockchain can guarantee this conversion.
It is something that anyone can look up. In fact, this site provides a real time reading of where the asset backing stands.
If the value, in USD, of $HIVE drops below the haircut limit, then the production of HBD ceases until the ratio is retaken. Conversions are also stopped preventing the supply from further being affected while the ratio is not maintained.
These are protective measures that UST did not have. Once the run started, it was game over. At no point was the production of the coins interrupted. Hence, the rush to the bottom was on.
With HBD, there is a point where the base layer basically freezes the production, allowing the system (and markets) time to adjust.
HBD Reduces The Counterparty Risk
As we can see, there are a number of ways that counterparty risk is reduced with HBD. When operating on-chain, we see the other side (the liability) is the blockchain itself. This eliminates the risk associated with the fragility of another entity.
At the same time, we see how the price of the backing asset is directly tied to the ability to create HBD. If that manages to cross the threshold, the system adjusts to compensate for this.
We need to consider the associated liability of any asset we are holding. Accounting tells us there is always another side to the transaction. Who is responsible for the liability is the question.
When it comes to money, HBD has a powerful liability in that we are looking at a decentralized blockchain as the counterparty.
This is a rarity in the cryptocurrency world.
One final thought: a smart contract is also counterparty risk.
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