> If you have $110 million in assets and $100 million in liabilities you are said to be levered 10:1
There is no single leverage ratio [1]. On an asset basis, this is an 11:1 leverage ratio, i.e. $11 of assets for each dollar of equity. A lot of miscommunication around leverage seems to stem from this ambiguity.
Yes, it seems he even mixed definitions as well. He said that the $110M in assets and $100M in liabilities was a 10:1 leverage.
However, later he says that a home owner with a down payment of 20% is levered 5:1. Yet, if we do the same math as he did above, then 20% of $100,000 loan is $20k in equity with an $80k loan, giving a leverage ratio of 4:1.
I came to the comments to check if that was correct - I was following that definition and calculated 4:1 in my head, too.
Later he uses the example of purchasing $2000 worth of ($10) stock by paying just $1000 and having the other thousand lent by the brokerage.
As per his definition, $2000 in stocks (assets) minus the $1000 loan (liability) equals $1000 in equity. Then if leverage = equity/liability, in this case it turns out to be 1:1
Where does the ratio of 10 to 1 come in here? I see 110:100, or 1.1:1, or 10%.
His explanation doesn't make sense to me. Are those assets borrowed or something? And having $10 million extra in assets means that if suddenly all your liabilities come due, you have $10m left over? How could that possibly wipe you out?
> the example as given seems to be $1.10 of equity (assets)
Equity (in accounting) is assets minus liabilities. $110mm assets, $100mm liabilities and thus $10mm equity.
You may be thinking of equities (from trading), which is another word for stock. (The link being equities represent ownership of equity, i.e. the value of a company’s assets net of liabilities.)
I think I'm having a slow moment... why are we more interested in the ratio of equity to liability, than the ratio of assets to liabilities?
It seems to me that if bad things happen, you can cover for the value of your liabilities with your assets. You could waste the entire excess equity on banana monkey NFTs and still be solvent, assuming no liquidity issues.
That ratio tells you how much faster you make or lose money under an asset price movement. That is, if you’re 11:1 leveraged, a 0.01% increase in asset price is a 0.11% increase in your net equity.
the key that they seem to delight in not telling you is that the 100M debt also came with 100M in assets - you borrowed 100M cash (an asset you now have) and promise to give it back later (a liability you now also have). Apart from those offsetting 100M entries on your books, you also have 10M other assets.
so you may have started with 10M - then you borrowed (and promise to repay) 100M more. there's your 1:10 (10:100) ratio.
This seems a bit too wordy to demystify the concept. Here's a simpler example.
1. Bank A offers you 5% interest for a 1 year deposit. You deposit $100 of your own money. You are unlevered. Things go well and after a year you receive $105, a neat 5% return on your investment. Or things don't go well, bank A turns out to be a scam and you receive $0, a -100% return.
2. Bank B offers you a loan for a year for 4% interest. You borrow $900, together with your own $100 you deposit $1000 at bank A. You are levered 1:9. Things go well and after a year you receive $1050 ($1000+5% interest) from bank A, you repay bank B $936 ($900 + 4% interest), so you're left with $114, a very neat 14% return (almost triple the unlevered return). Or things don't go well, bank A turns out to be a scam and you receive $0. But now you still owe bank B $936, so together with your own $100 loss you made a -1036% return. Oops.
p.s. It's called leverage because (like a physical lever that allows you to lift something much heavier than without) supplementing your own funds with lots of borrowed money allows you to tackle something much bigger than using only your own money, like buying a house or starting a business or getting 5% on $1000 instead of on $100.
Btw, a great, well known quote from John Kenneth Galbraith (from A Short History of Financial Euphoria) is:
"The world of finance hails the invention of the wheel over and over again, often in a slightly more unstable version. All financial innovation involves in one form or another, the creation of debt secured in greater or lesser adequacy by real assets."
In the 2008 financial crisis, some have paraphrased this as "All financial innovation is leverage dressed up as something different."
That's actually a fascinating error that people make with fixed-income investing; too much focus on safety of principal vs. actual compounded yield and recovery rate in the case of default.
In New Zealand, most fund platforms have a custodian - an entity that holds the assets you buy on the platform. If the platform busts, you’re safe because your assets are held with the custodian and not the platform.
But that then begs the question, what happens if the custodian goes bust? Well custodians also have a custodian, diversifying the risk one step further (but not completely). Custodian inception!
It's a useful thing to keep in the back of your head to inoculate yourself against marketing shenanigans.
The basic underlying principle of a product/service should be communicable and relatively universal. The details are of how it's tailored to your specific situation should come with cons and unknowns in other situations.
If it's not communicable and/or sounds like there are no cons they're not being honest about what it is (intentionally or unintentionally).
There are some useful distinctions to be made. Insurance, for example, could be seen as "negative leverage", but it really is a different kind of animal.
I'm not a fan of your examples because taking on leverage for fixed income assets is not the most common use of leverage, precisely because the rewards aren't that much better but the risks are so high. Also, "being a complete scam" is not the most common downside risk in leverage.
I think an easy example nearly anyone can understand is their mortgage. You put down $50k for a $500k house. The house goes up just 10% to $550k, if you sell you've doubled your money after repaying the $450k you've borrowed. Of course, if the price goes down 10%, you're completely wiped out.
Sure, mortgages are the most common example of leverage for non financial pros. But that's also a reason not to use it as an example. Because even if they're levered 9:1 nobody thinks they're wiped out if their house price goes down 10%, they'd think they just need to hold on to it till it recovers.
> Because even if they're levered 9:1 nobody thinks they're wiped out if their house price goes down 10%, they'd think they just need to hold on to it till it recovers.
Amazing how time flies. I'm pretty sure anyone who was old enough to own a home in 2007/2008 in a "hot" market knows exactly how mortgage leverage can work on the downside.
>knows exactly how mortgage leverage can work on the downside.
Sorta... Usually when people talk about that, it's mostly in the context of balloon payments and variable rate mortgages where the value of your house dropping coincided with sudden increases to your monthly mortgage payment or large bills coming due.
Partially, but a big difference is that tons of lenders were giving out mortgages in the mid 00s with no or very little money down. When things turned south, people were underwater really quickly, so was easiest/best to just mail the keys to the lender, especially in non recourse states.
You could simplify this further by making it a bit more abstract:
You have $100 worth of stock in Google. You think Google stock is going to appreciate so you borrow $50 of my money to buy more stock. I see that you have $100 worth of Google stock which provides me with some security that you have a valuable asset and are a worthwhile borrower.
But, instead of Google's stock value increasing it starts to fall. You took my money and I'm getting nervous so I force you to sell your Google stock. At one point you had $150 worth of Google stock but now I've forced you to sell your stock for a total of $75 which allows me to recoup my lent money ($50) plus my fees and I really don't care how much money you are left with, if any.
This is important for the economy because credit (which this is) helps create growth and drives economies - when credit is tight then economies grow slowly if at all.
This is a bad example because no broker would force you to sell your own equity.
You had 100 dollars, you're leveraging 50 cents for every dollar you put in giving you a .5:1 leverage ( or 50%, or 1.5/1 as a fraction)
Only if the stock loses more than 100 dollars in your equity would the broker be worried and ask for margin. This means your $150 dollars of leveraged stock would have to drop to $50 dollars before the broker would be worried and sell your stock to get their $50 back. This means your stock could drop 66,7% or 2/3 as a fraction.
All fees are paid upfront and the rest from your margin. Not your stock.
Perhaps you're arguing that the leverage ratio I used as an example was extreme, but otherwise you are wrong that "no broker would force you to sell your own equity."
If there's a margin call and you don't deposit additional cash, then a broker will force a sale of the stock. "Brokers may force a trader to sell assets, regardless of the market price, to meet the margin call if the trader doesn’t deposit funds."
P.S. It is also called leverage because the same rule of proportionality applies: With a 10x physical lever, e.g. the lever is 10 cm on one side of the fulcrum and 100 cm on the other, moving one end of the lever by 1 cm will move the other end by 10 cm. With 10x financial leverage, e.g. you use $10 of equity (your own money) and $90 of debt (borrowed money) to invest $100 in assets, an extra +1% return on assets corresponds to an extra +10% return on equity.
Was going to say something very similar. His content is usually great, but the writing style doesn't appeal to me because of the verbosity. It generally doesn't keep me from reading them if the topic is interesting to me though.
Anyways, this is all very subjective and based on personal preference so it's probably not useful so I'll shut up now.
> Was going to say something very similar. His content is usually great, but the writing style doesn't appeal to me because of the verbosity. It generally doesn't keep me from reading them if the topic is interesting to me though.
I appreciate that patio11 states things that might seem obvious to someone knowledgeable in a field. It reminds me of [WP:Obvious] from back when I started using Wikipedia. It states:
> State facts that may be obvious to you, but are not necessarily obvious to the reader. Usually, such a statement will be in the first sentence or two of the article.
This is such a difficult thing to do "correctly" because there is a danger as you see on the wikipedia link that you might start stating that the sky is blue. (Meta: Did I just do that?)
This is what patio11 does so well.
I mean this is pretty early on in the article:
> Every business has a balance sheet, which contrasts its assets (valuable things it owns) against liabilities (valuable things it owes to other people). The difference between assets and liabilities is equity.
> Financial businesses will frequently have non-financial assets and liabilities. Ignore those for the sake of simplicity. Ignore the nice building, the computers, the payroll due on Friday for work which has already been completed. Focus just on the financial assets and liabilities, things like “mortgages our bank owns” (asset) and “deposits from customers” (liability).
> Leverage is the ratio of your liabilities to your equity. Simple division. Fourth grade math. If you have $110 million in assets and $100 million in liabilities you, by subtraction, have $10 million in equity against your $100 million in liabilities. You are said to be levered 10:1.
Now if I were to edit this,
I'd probably go off a tangent at this point.
I would say something silly like
You have deposits from customers worth USD 100M.
You loaned out USD 110M.
What happens if, of the people you loaned your money to, half of them disappear with your money?
Now, your assets are only USD 65M.
However, your liabilities are still USD 100M.
Your equity is USD 65M - USD 100M = a negative USD 35M!
You are properly screwed.
In fact, you'd be screwed if your loans soured by anything greater than your equity of USD 10M,
let say USD 11M.
Lets say your borrowers are unable to repay you any more than USD 99M of the USD 110 they owe you.
Your equity is USD 99M - USD 100M = - USD 1M.
What just happened?
I took you, the unsuspecting reader, on my boat and threw you out in the middle of the ocean.
I've done you a disservice.
Did you expect to read that tangent after the quote I had from patio11?
Probably not.
Did you expect to see a concept like negative equity and negative leverage if you're just learning about leverage?
Unlikely.
In any case, the fact that I feel dissatisfied just writing this comment is a testament to just how difficult it is to explain something. Even when the concept I am trying to explain is nothing more than "it is difficult to explain something in brief".
I find this uncharacteristically hard to understand.
In the stock brokerage example, we're told:
>They might allow you 2:1 leverage when you buy stock: your $1,000 buys 20 shares now.
But then a couple of paragraphs later:
>But you now owe $1,000 to your brokerage, and are 1:1 levered
My brokerage offers 2:1 leverage, which results in me being 1:1 levered? I think I understand what patrick is saying here but I also find it hard to follow
On the other hand:
>One is that, because people can ask for money from their checking accounts at any time, impecunious operation of the bank could cause the value of the mortgages to be impaired just a tiny little bit at a time when people need most of the money in their checking accounts.
I've read this four or five times and I don't understand the chain of cause-and-effect here at all. Why does "people can ask for money from their checking accounts at any time" mean that "impecunious operation of the bank could cause the value of the mortgages to be impaired just a tiny little bit at a time when people need most of the money in their checking accounts"?
The first one seems like confusing word choices to me. They allow you to buy 2x as much stock as you are putting money down (2:1 leverage when you buy stock). After you do so, you have 10 shares that you own to 10 shares that you control by don't own (and therefore are 1:1 levered).
The second one is only confusing because you're trying to find a cause and effect between 2 events that simply happened to happen at the same time. Though in practice the events may have an underlying common cause and so do show up more often than you'd expect.
A concrete scenario is a community bank in a place where a major employer just did a layoff. The value of the mortgages is now impaired because some people won't be able to pay them back. The laid off people also need most of the money in their checking accounts because they have no job. The bank now has a challenge - its cash reserves don't meet anticipated needs, and it can't sell the mortgages to get more cash.
The troubled bank has a good chance of surviving unless the third leg of the trifecta shows up - word gets out about the bank's trouble. Now everyone scared of losing their checking accounts all show up to withdraw money at the same time. The bank doesn't have the cash for this "run on the bank", and goes bankrupt.
This scenario was historically common. People accepted it until there was an event during the Great Depression where enough banks went under at the same time that people got scared about what were otherwise healthy banks. Even though their assets were good, they couldn't pay out all accounts at once, and began going under en masse. FDR took fairly drastic actions to fix this (bank holiday, confiscating gold, etc) and then put in the FDIC to stop it from ever happening again.
There is a well-known portrayal of this run on the banks in the movie, It's A Wonderful Life.
>The second one is only confusing because you're trying to find a cause and effect between 2 events that simply happened to happen at the same time
The author uses "because", which in context clearly indicates to me a cause and effect relationship.
Even overlooking that, "impecunious operation of the bank could cause the value of the mortgages to be impaired" is not addressed by your explanation. You explain how external factors could reduce the value of the mortgages.
You have a point, and I think there is a bit missing. Currently it says:
... impecunious operation of the bank could cause the value of the mortgages to be impaired just a tiny little bit at a time when people need most of the money in their checking accounts.
And probably should say something like:
... impecunious operation of the bank could cause trouble if the value of the mortgages is impaired just a tiny little bit at a time when people need most of the money in their checking accounts.
Patrick McKenzie makes the usual smart person mistake of trusting their intuition on finance because it has served them well in other domains.
In this case the pertinent question to ask oneself a priori is: "if, as I believe, tether breaks down what are the chances that people will be defaulting on Defi platforms thus turning my clever trade in a catastrophe where I lose my principal?"
This is what traders call "wrong way risk" - your trade becomes self-defeating. An example.od this from real life is JPY cross currency basis swaps. A cross currency basis swap consists of 2 back to back loans in different currencies. Japanese investors have excess JPY and seek to convert it to USD via this mechanism so they can buy higher yielding assets in USD. Cross currency basis swaps attract a premium, in this case as the flows are predominantly lending JPY, the lenders get a lower interest rate than the prevailing market rate. The problem arises if you are a US or European bank and wish to do this trade with a Japanese bank. If there is a JPY crisis the premium will become even more negative as Japanese entities scramble to get USD in to meet liabilities by lending JPY. As the foreign bank you will have a mark-to-market profit on the JPY you lent but your Japanese counterparty may well be unable to pay due to the unfolding crisis in Japan.
> In this case the pertinent question to ask oneself a priori is: "if, as I believe, tether breaks down what are the chances that people will be defaulting on Defi platforms thus turning my clever trade in a catastrophe where I lose my principal?"
I am extremely aware counterparty risk in DeFi protocols, which is why I have a toy-sized position and only put that on once someone explained to me, persuasively, that in futures where DeFi explodes I will gain more utility from the story than I will lose from a toy-sized position. I have sometime sardonically referred to this as 'mining comedy gold.'
This is also why, when people ask me how to short Tether, I try my darndest to avoid blessing any particular mechanism, because you can be right and still lose everything, as you're aware. I have been saying that on HN since before DeFi existed as a concept.
Nice writeup. A good popular discussion of leverage is in the movie Margin Call, regading the 2008 meltdown:
> "Well, as you probably know, over the last 36 to 40 months, the firm has begun packaging new mortgage-backed security products that combine several different tranches of rating classification in one tradeable security. This has been enormously profitable... Well, the firm is currently doing a considerable amount of this business every day. Now the problem, which is I guess why we are here tonight, is that it takes us, the firm, about a month to layer these products correctly, thereby posing a challenge from a risk management standpoint... Well, we have to hold these assets on our books longer than we might ideally like to. But the key factor here is, these are essentially just mortgages, so that has allowed us to push the leverage considerably beyond what you might be willing or allowed to do, in any other circumstance, thereby pushing the risk profile without raising any red flags."
Running the money printing press was the government response to that situation, i.e. 'deleveraging the bank holding companies (BHCs) via quantitative easing' - which does illustrate how a government controlled by financial oligarchs operates in practice. The actual homeowners could have been the recipients of the bailouts - i.e. the government would have taken over their loans, provided a zero-interest period, converted the loans from adjustable to fixed-rate, sold them back to the banks (or just set up a separate institution), and then the homeowners could have stayed in their homes and continued to pay off their mortgages at an acceptable monthly rate - or some combination of the above. The BHCs would have suffered much more significant losses under that scenario, and perhaps more would have gone the way of Bear Stearns and Countrywide.
Notably, this illustrates that regardless of whether monetary policy is tight or loose, the government's fiscal policy can be engineered to support the financial oligarchs. For example, today's high interest rates are going to be used to justify government fiscal policies that benefit the oligarch class (i.e. pushing for mass unemployment to bring down wages to 'fight inflation', etc.). Similarly, large banks are not being forced to raise personal savings interest rates as the Fed rate rises (as that would benefit ordinary people, even if inflation is outpacing interest rates).
As far as cryptocurrencies, it seems fairly unlikely that crypto funds will be the beneficiaries of quantitive easing or other government largesse, as crypto hasn't yet bought enough corrupt politicians.
> Interestingly, their customers are also often levered. A homeowner who has just made their 20% down payment is levered 5:1.
Isn't that only if the homeowner has no other equity or liabilities? Which is especially tricky when talking about people who, if we valued them like we value corporations, have equity in the form of the net present value of their future earnings.
Yes, he’s simplifying by assuming the home owner’s other assets and liabilities are small enough that they can be ignored. And also, there are different ways to do valuation.
The “book value” of equity according to accounting is just (assets - liabilities) and doesn’t include the company’s own future earnings. That’s what’s discussed in the article. Stock is also referred to as equity and its market value is whatever the market believes a company is worth and presumably does include future earnings according to whatever crystal ball it uses.
In this case we assume a house (valued at its purchase price) is the only asset. I get 4:1 though, assuming debt:equity.
It’s simple math, but definitions can be tricky and the article would be a whole lot clearer if he showed his work.
Well the bank can't get your future earnings or other assets if you default, but they can get the house. So if the house is worth zero dollars (never true) then you are 5 to 1 leveraged.
There are numerous scenarios where the house is worth less than zero dollars. For example when there's a large overdue tax bill attached to the property.
Or it's in extremely bad repair and will need to be torn down before you can rebuild on the land. If you look at listings for land, a surprising number of them are actually listings for "houses not fit for human habitation".
The land itself is worth about 35-50 percent of the house depending on ___location. So there are never situations where the value of the house is worth zero.
It is entirely possible for land that house stand on being nearly valueless. Think of really rural or low demand area. And on other hand house it self being expensive to take down. Maybe containing mold or asbestos.
The cost of getting rid of the house - or other liabilities - is sometimes higher than the value of the land itself. There are situations of zero and even negative value.
> in the specific case of mortgages, because they're no-recourse
This varies jurisdiction to jurisdiction. And it isn't really germane to the question of quantifying one's leverage, which is a going-concern analysis.
I'd say "leverage" is the slightly affirmative, slightly pejorative term for a phenomena that could also be labeled 'fractional reserve banking'.
Read the Federal Reserve's on words on what they 'guide' banks to do with deposited funds:
> The Federal Reserve is carefully monitoring credit markets and is prepared to use its full range of tools to support the flow of credit to households and businesses and thereby promote its maximum employment and price stability goals
Following the "quacks like a duck" rule, a fractional reserve 'policy' and 'using leverage' look very similar. Both root in criminal misuse of deposited funds.
There is nothing new under the sun:
Leverage, fractional reserve banking, and most of the shenanigans in crypto are all violations of the legal principles governing the monetary irregular-deposit contract.
I _love_ reading anything new by patio11, so absolutely just took a long break from my day to read this and leave the comment. Thanks much! Looking forward to the next BAM!
Off-topic, but can somebody recommend me a book on economics? I need to learn how things generally work in the world and how to manage my money. I'm almost 25 and I have zero clue what I'm doing besides "I need a bigger salary and save more".
i must be missing something, but how does this even remotely check out?:
> Leverage is the ratio of your liabilities to your equity. Simple division. Fourth grade math. If you have $110 million in assets and $100 million in liabilities you, by subtraction, have $10 million in equity against your $100 million in liabilities. You are said to be levered 10:1.
how are you levered 10:1 when assets > liabilities? really feel like i am missing something.
You started with $10 million. You took out an interest-free loan for another $100 million, so you have $110 million in assets (the money) and $100 million in liabilities (the debt).
You’re levered 10:1 because you have $100 in borrowed assets you have to pay back and only $10 million in assets you fully own.
Every time you borrow cash with an asset as collateral - a house loan, a car loan, an iPhone loan, a 401k loan, a margin loan - it could all be said to be a leveraged long in some sense.
Or would you say that you're against the idea of borrowing against stocks specifically?
Its just pretentious BS used as a smokescreen for _gambling with your money_.
What has happened with FTX is a demonstration of the value of a block chain and the concept of user-controlled wallets versus banks. FTX did what banks do, which is to take a cut of transactions, and especially use customer funds to make bets (that eventually they could not cover, even with all of your funds).
Using centralized exchanges to speculate is a ridiculous perversion of the concepts in cryptocurrency.
The basic advances of cryptocurrency are:
1) digital signatures used in transactions rather than disclosing secrets such as credit card numbers
and
2) a public ledger that is cryptographically verified with chains of blocks
Decentralized exchanges are probably usually also often nonsense speculation, but if done right they can at least benefit from 2 which means you can see what they are doing and not be surprised at the last second about some secret "over-leveraging".
This is why actually if people can understand what's happening and what cryptocurrency is, this is another incident that is a very good advertisement for cryptocurrency.
Because actually the idea is that instead of relying on some third party to follow some words on paper, you trust math and computer science. You don't need the third party at all for most things, just use you own cryptocurrency wallet.
For more complex things, we can use smart contracts, which are not based on trust but actual math. The program being on-chain literally makes it impossible for them to misappropriate funds (at least without the details being in public and reviewable beforehand).
Things that regularly go wrong in cryptocurrency go wrong in cryptocurrency and that is an argument for using cryptocurrency???
I couldn't make this up!
As for the "smart contracts", nobody who is familiar with programming bugs would want there not to be better checks and balances there. The depressing frequency of 8 figure hacks of the terms of said contracts is a concrete demonstration of this principle. Thanks, but no thanks in anything like its current state.
For most users, traditional finance is faster, cheaper, and safer in practice than crypto. Which is exactly why the main use cases for crypto are speculation, money laundering, and various illegal activities like paying ransoms for ransomware attacks.
I have written and effectively used many smart contracts, although not for speculation.
There is constant abuse of customer funds, as a matter of course, by banks. It generally is less public or visible though than public ledgers (blockchains).
Its the difference between trusting a company that is trying to profit just from holding your funds in ways that you cannot audit, versus trusting a math and computer programs that you can audit.
There have not been more abuses by cryptocurrency exchanges than banks overall. They are just more recent. But what I am saying is that these cryptocurrency exchange companies really don't have anything to do with cryptocurrency -- their business model is antithetical.
The banks have a zero-percent reserve ratio allowing them to "loan out" (and have deposited in their own bank as new funds) 100% of the 'digital assets' in their account.
There is nothing inherently wrong with banks lending out your deposits. This system is how a majority of new businesses are funded and how the economy expands. There are a mountain of regulations that banks have to keep up with and the reason why FDIC insurance exists. Investors entering the crypto space willingly rejected these regulations and are now finding out their purpose the hard way.
It's similar to the situation with credit cards. There is a whole industry related to working around the problem of constantly disclosing the secrets, such as refunding stolen funds.
Likewise we have had to rely on banks to control digital money since we did not have a good alternative. And now there are many regulations and compliance officers etc. dedicated to preventing people from cheating, stealing, or irresponsibly using customer funds.
But at the core level the problem is that these the bank ledgers are secret, difficult to verify or connect together for tracing purposes. Cryptocurrency means using math and computer science to solve these types of problems in a holistic way.
Like everything else, people have abused this technology (such as using it to sell services that are antithetical to the core concept). But that doesn't mean they aren't important advances.
Yeah especially after 2008. I heard a joke from someone who works at a big bank that after 2008 there are 2 compliance people for every one banker. People in finance like to make fun of the "back office" but they seem to be main reason the bank stays solvent.
> There is nothing inherently wrong with banks lending out your deposits.
There wouldn't be anything inherently wrong with it 1) if they didn't do it by default 2) if banks informed their customers appropriately, including the risk in doing that (most people don't know what banks do with their funds) and especially 3) if it wouldn't be forced, i.e. if they would let customers choose to keep their funds segregated if they are not willing to take the inherent risk in lending and/or the bank mismanaging their funds (e.g. having the option to have both segregated and normal checking/savings accounts or whatever), so that customers would never be exposed to losing whatever amount they didn't want to (including anything above the FDIC insured amount).
But sure, allow customers to lend their money and expand the economy if they want to. With an appropriate reward for the risk, not a laughable 0% interest rate, which almost nobody would ever take willingly. In fact, the 0% interest rate, or anything below or close to the inflation rate, is a clue which indicates that what they're doing to their customers is wrong and that the customers aren't choosing to take that risk knowingly and voluntarily.
> There are a mountain of regulations that banks have to keep up with and the reason why FDIC insurance exists
You say that like it's a good thing. It's massively inefficient and both "a mountain of regulations" and FDIC insurance are inherently unfair (for several reasons) and have many unintended (negative) consequences.
And it doesn't even actually fix the problem, it just makes it less likely to occur (for starters, because there ends up being much less competition than there would be otherwise -- less banks, less bank failures) but when it occurs, it's an even bigger problem. Which means it also gives a false sense of security.
> digital signatures used in transactions rather than disclosing secrets such as credit card numbers
Credit cards also offer this. I can go to my CC's website and generate virtual cards which can be handed to vendors and individually managed, frozen, or deleted, all without exposing my actual card number.
You're still exposing your virtual card number which gives permission to charge money from your actual credit card. Normal credit cards can also be individually managed, frozen and deleted but that doesn't prevent unauthorized charges.
Deleting a virtual card is tremendously easier than revoking my primary credit card number and updating all the vendors that are using it. It's quite easy to use a virtual card once and then delete it immediately. Furthermore, I'm not worried about a virtual card being exposed to unauthorized charges, because (unlike in cryptocurrency-land) chargebacks exist.
> Deleting a virtual card is tremendously easier than revoking my primary credit card number and updating all the vendors that are using it. It's quite easy to use a virtual card once and then delete it immediately.
Still harder and not as secure as a digital signature.
> Furthermore, I'm not worried about a virtual card being exposed to unauthorized charges, because (unlike in cryptocurrency-land) chargebacks exist.
You're not guaranteed to perform a chargeback successfully. And both vendors and customers (like you) are paying for that "service".
Chargebacks are also one of the reasons for why there is large-scale credit card fraud. And it is also why vendors are incentivized to collect personal information from you (to detect fraud before chargeback happens, for which they are greatly penalized) and why they are also incentivized to refuse service to legitimate customers in many cases (due to flagging legitimate transactions as suspicious).
Worse, when they refuse service they cannot even tell you why (as that would help fraudsters).
> You're not guaranteed to perform a chargeback successfully.
Even in the worst case, because a credit card is an abstraction over my bank account, I have the option to refuse to pay and won't lose my shirt or otherwise become despondent. In the meantime, chargebacks are a feature of the system, not a bug. To wit, cryptocurrency advocates are the last people who should go around lecturing others about fraud. :P
> Even in the worst case, because a credit card is an abstraction over my bank account, I have the option to refuse to pay and won't lose my shirt or otherwise become despondent.
That may also have unintended consequences for victims of credit card insecurity.
> To wit, cryptocurrency advocates are the last people who should go around lecturing others about fraud. :P
Why not? Cryptocurrency advocates know a lot more about it than most people (for good and bad reasons).
In cryptocurrency land there is no such thing as an unauthorized charge because you don't ever give a third party access to information that can be used to charge funds, which you have to do constantly with credit cards.
> Since token approval requests usually ask for unlimited access to your token balance, if there is a security vulnerability, all of the assets in your wallet could be exposed. Depending on how severe the security vulnerability is, disconnecting your wallet from a dapp may not be enough to fully protect your assets.
Exactly.. of course we still have very significant problems to solve.
Such as the fact that most of these cryptocurrencies are totally impractical to use for actually buying things, leading to the need to use centralized exchanges for swapping to fiat.
And the fact that there are multitudes of competing cryptocurrencies. And that there is a fundamental lack of integration with government due to government actually needing to radically reform and advance to incorporate cryptocurrency.
But still, they are core advancements that society should take advantage of. Easier said than done.
FWIW, even when they request unlimited access, you can set whatever limit you want. In MetaMask, the defacto standard wallet, you simply just edit the field that appears in the request/confirmation dialog.
Where "outdated" and "workaround" here means that it integrates with existing payment processors and therefore works with 99% of the things that you want to buy. There's nothing unique about cryptocurrency solutions in this case that traditional credit cards cannot achieve, and any fancier solution just means that you can't actually use it anywhere.
You promise you'll fix Johnny's roof for $200. He hooks you up with a computer for $300. You pay him the difference of $100. You have transacted for $500 but only circulated money of $100. That's 5:1 leverage.
Futures markets work on this principle, among many other things.
You're alluding to operating leverage [1]. The carrying cost of the computer and cost of services for the labor being working capital constituents.
This is distinct from the financial leverage, which deals with explicit borrowing. (Futures markets do not work on operating leverage. They work on offsetting financially-levered claims.)
No, what I'm describing has nothing to do with fixed or variable costs.
What I'm saying is that when you separate the action (fixing roof, hooking up with computer) from the payment, you're in debt, you're creating an implicit loan.
If you then clear this debt not by opposing transactions but with just the minimal set of transactions (similar to ring clearing after a poker game) then you have allowed transactions with far more money than any party actually produced cash for.
That is financial leverage.
That is exactly what happens in future markets, too. You don't need cash corresponding to the full value of a 5000 bu wheat contract to buy one. All you need is enough to cover the mark-to-market payments and then a little safety buffer. It's all an implicit loan until the contract expires. If you offset it, you continue to transact in way more money than you put in. Financial leverage!
> what I'm describing has nothing to do with fixed or variable costs
I linked to an admittedly terrible Wikipedia article. What you're describing involves leveraging working capital, a form of operational leverage. Every business does this. Restaurants are operationally levered--they serve you food before you pay. In your example, services were rendered in anticipation of payment. None of this is financial leverage.
> offset it, you continue to transact in way more money than you put in
This is netting. The loan is explicit in a way distinct from operating leverage. These differences are meaningful in both how we measure the phenomena as well as the law.
Right but you pay the restaurant the full price of the meal in cash. The amount of cash circulated exactly equals the market price of the services provided. I'm not saying that's financial leverage.
Financial leverage happens if you and the restaurant would begin to clear debts in ways that mean you can enter into business for larger amounts than the cash you can pony up.
> Your stock brokerage, though, is willing to offer you leverage on your assets. In return for a fee (and to gain your business, because this is considered a high-saliency feature for the customers of brokerages), they will lend you money against your assets, allowing you to buy more Google than you had cash for. They might allow you 2:1 leverage when you buy stock: your $1,000 buys 20 shares now.
Not widely known, but it's the US Federal Reserve that tells stock brokers how much leverage their clients are allowed to assume. This is one of the most potent tools in the Fed's toolbox, and it has not used it since 1974:
Forget the sissy Fed funds rates, forget the lamo QE/QT ceremony, if the Fed really wanted to take compulsive gamblers to the woodshed, all it needs to do is raise the margin requirement, thus de-leveraging brokerage customers by force.
Whenever the topic of hash-related gambling catastrophes comes up, there's always an outcry for MOAR REGULATION.
If history had demonstrated that regulators not only knew when to use their tools but that they could wield them in a wise and timely manner, that would be one thing. But time and again regulators do the wrong thing at the wrong time.
Leverage is and has always been stealing from Peter to pay Paul. People can justify it however they want and do, but the fact remains profit is supposed to be the signal that an operation is a viable going concern. Leverage masks this and trades the long-term for the short-term.
Most companies use leverage so their c-suite can make more while producing less. That's the truth. It's bullshit and should be outlawed. Corporations need to compete based on inputs and outputs.
Labor creates value. Leverage creates a mirage.
Feel free to disagree. Enjoy your business cycles.
There is no single leverage ratio [1]. On an asset basis, this is an 11:1 leverage ratio, i.e. $11 of assets for each dollar of equity. A lot of miscommunication around leverage seems to stem from this ambiguity.
[1] https://corporatefinanceinstitute.com/resources/accounting/l...