Archive for June 18th, 2021

The Opportunities and Dangers of Decentralizing Finance

June 18, 2021

Wharton legal studies and business ethics professor Kevin Werbach and David Gogel in this K@W article (and podcast):

DeFi is a developing area at the intersection of blockchain, digital assets, and financial services. DeFi protocols seek to disintermediate finance through both familiar and new service arrangements. They use stable-value cryptocurrencies known as stablecoins as assets, blockchain ledgers for settlement, and software-based smart contracts to execute transactions automatically.

The market experienced explosive growth beginning in 2020. According to tracking service DeFi Pulse, the value of digital assets locked into DeFi services grew from less than $1 billion in 2019 to over $15 billion at the end of 2020, and over $80 billion in May 2021. Novel business models such as yield farming — in which holders of cryptocurrencies earn rewards for providing capital to various services — and aggregation to optimize trading across exchanges in real-time are springing up rapidly. Innovations such as flash loans, which are either repaid or automatically unwound during the course of a transaction, open up both new forms of liquidity and unfamiliar risks.

Despite its scale and potential significance, DeFi is still early in its maturation. Now is the time to evaluate its benefits and dangers. As with everything in the cryptocurrency world, hype around DeFi is sometimes out of control. Extraordinary — and unsustainable — short-term returns warped investor expectations and attracted bad actors as well as innovative builders. Most DeFi activity is still speculative and conducted by relatively sophisticated cryptocurrency holders. As mainstream usage grows, risks and regulatory considerations will loom increasingly large.

Central banks as golden goose

June 18, 2021

In its monthly Bulletin, RBI econs have been writing on the State of Economy which has generated fair bit of discussion.

In the Jun-2021 edition, the researchers react to the recent RBI transfer of surplus to the government.

An aspect of the Annual Report that has raised considerable heat and dust in the media is the surplus transferred to the government. Mainly stemming from saving on balance sheet provisions and employees’ superannuation and other funds, the surplus constitutes just 0.44 per cent of GDP (which is taken as a measure of seigniorage).

“In flow terms, we can think of the central bank as the government’s golden goose. With an unimpaired balance sheet:

• The free-range goose conducting conservative monetary policy with a fair degree of independence produces golden eggs in the form of seigniorage worth 0.5 to 1 per cent of GDP;
• The battery farm goose, bred specially for intensive egg-laying, can produce golden eggs n the form of an inflation tax yielding 5 to 10 per cent of GDP;
• The force-fed goose can produce revenue of up to 25 per cent of GDP for a limited period before the inevitable demise of the goose and collapse of the economy. All three forms of central bank geese have been sighted in recent years.”

From the point of the surplus transfer alone, therefore, the Reserve Bank can be characterised as ‘free-ranging’ and conducting independent monetary policy, i.e., independent of fiscal dominance (Table 2).  

 


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