Why Most Money Fails | Money for The Rest of Us

Welcome to Money For the Rest of Us. This is a personal finance show on money, how it works, how to invest it, and how to live without worrying about it. I’m your host, David Stein. Today’s episode is 387. It’s titled “Does Any Money Last?”

The Global Decentralized Money Markets on the Blockchain

In February 2022 I received an email from Ronald AngSiy. He’s the senior vice-president of strategy for Intellabridge, a publicly-traded company. Intellabridge was interested in sponsoring the Money For the Rest of Us Podcast. AngSiy wrote:

“Our company offers 10% stable interest on cash deposits, with a VISA/Mastercard debit card to spend against it.” Better than a bank savings account, right? “We accomplish these interest rates by taking in the funds and automating the process of plugging them into global decentralized money markets on the blockchain. We enable people to have these capabilities without any technical expertise required.”

I had never heard of this company, but I was intrigued. 10% stable interest? I told them I would pass. I wanted to spend more time understanding their savings product, which is Kash. I also replied “I love the innocuous-sounding phrase “global decentralized money market accounts on the blockchain.” That sounds safe, except for the blockchain part.

In doing research on Kash in Intellabridge, I’ve found an article from April 2022 in which Maria Eagleton—she’s the COO and founder of Intellabridge—she said in that interview “Kash is a Mastercard-incubated, publicly-traded company (the ticker is KASHF) offering 10% stable interest rate savings accounts. We care more about the customers than competitors. Our customers can trust us, as we are thought leaders in the industry, co-publishing reports with Ivy League institutions like Wharton’s Innovation Institute.”

Notice all the phrases to build credibility—Mastercard-incubated, publicly-traded, thought leaders with other Ivy League institutions.

Eagleton goes on: “Kash combines the values of traditional banking plus the benefits of blockchain technologies. This enables us to offer a higher annual interest rate by disintermediating the cost structure of traditional banks. 10% on savings, which helps families, businesses, and non-profits fight inflation with a living savings rate.” Who wouldn’t want a living savings rate? 10%, by going around the supposedly bloated commercial banking industry.

On May 7th this year the official Kash Twitter account tweeted “Hey, Kentucky Derby fans, have fun rooting for your horse. Just know that outside the Kentucky Derby you can get a GUARANTEED (they capitalized that) 10% on savings. We’re a Mastercard-incubated public company. Kash.io.”

On May 8th Kash tweeted in a reply, “In crisis, people flee to cash. The ability to earn 10% interest on cash deposits during these crisis moments is game-changing. Tell everyone that any individual, business, and non-profit account can escape today on Kash.io.”

It sounds pretty enticing, doesn’t it? Flee to Kash, and earn 10% by plugging into the global decentralized money markets on the blockchain.

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Traditional Money Markets

What are money markets? Money markets are markets that consist of borrowing and lending in short-term debt. Typically, the debt has a maturity of fewer than 13 months. You’re probably most familiar with money markets through investments in a money market mutual fund. Money market mutual funds accept deposits from individuals and invest that money in high-quality ultra-short-term debt issued by governments and corporations.

The average maturity of the debt for money market mutual funds is about 60 days. And the value doesn’t fluctuate much. They seek to keep the net asset value at $1 per share. Similar to a bank checking account, money market fund customers can withdraw their money at any time, and many offer the ability to write checks against their account balances.

A money market mutual fund is private money. It’s an IOU from the money market mutual fund’s sponsor, which means money market funds can experience runs where depositors demand all their money back.

We looked at that in episode 333 of the podcast, “How the COVID shock nearly destroyed the financial system.” We described how the Federal Reserve back-stopped money market mutual fund accounts in the U.S, retail money market mutual accounts, to stop a bank run.

So when Kash is tweeting that “We will help you invest in money markets”, I think safety, cash-like investment. But you can’t have your cake and eat it, too. How can an app offer 10% on savings? Guaranteed, they say, according to their Twitter account. In addition, they were offering me as a potential sponsor 10% of the revenue that they were getting from customers.

As I dug into this more, it turned out that deposits at Kash, the app, weren’t invested in traditional money market accounts. How could they? They didn’t pay anywhere near 10%. Instead, the funds were being deposited in Anchor, which is a protocol that’s part of the Terra ecosystem. Terra has a stablecoin called TerraUSD (UST). In fact, Terra has a number of stablecoins in different currencies. But Kash, the app, was investing in the TerraUSD stablecoin through Anchor. And Anchor was paying 20% interest, which means Kash was keeping half the money and then giving half to its depositors.

On Terra’s website, it says “Terra is a public blockchain protocol deploying a suite of algorithmic decentralized stablecoins, which underpin a thriving ecosystem that brings DeFi to the masses.”

Last fall I was researching the Terra ecosystem and I watched a video in which it said Anchor, this savings protocol, can be thought of as a bank on the blockchain. Terra attempted to keep a one-to-one peg to the U.S. dollar, the Terra USD.

True and Algorithmic Stablecoins

We looked at stablecoins a few months ago in episode 373, “Are stablecoins safe?” We learned there are two types of stablecoins: true stablecoins and algorithmic stablecoins. True stablecoins are backed by collateral that is stored off-chain. That collateral consists of short-term government bonds and commercial paper which is ultra-short-term commercial debt. In other words, true stablecoins are similar to money market mutual funds. The largest true stablecoin is Tether, UST.

Algorithmic stablecoins are different. They’re completely on the blockchain, and there is no collateral. The peg is maintained by individuals with financial incentives. Those individuals, those traders are the ones that step in to support the peg.

In episode 373 I said it doesn’t always work. And at the end, we answered the question, “Are stablecoins safe?” “Sort of”, I said. True stablecoins are generally safer if we’re judging safety by measuring volatility. True stablecoins have done a good job of keeping their peg, just like money market mutual funds have, generally.

Algorithmic stablecoins, I said, are less safe. Because if there aren’t enough people participating, enough traders willing to support the stablecoin, to maintain the peg, then the stablecoin could crash.

The Collapse of Kash, TerraUSD, Luna and Beanstalk

With Terra USD, the way that it worked was when Terra USD (UST) slipped below a dollar, a trader could exchange UST for LUNA. LUNA is a separate coin; it’s a sister coin to Terra USD. So the peg slips, the trader steps in, hands off some UST, gets some LUNA in return, and then that UST is destroyed or burnt, which reduces the supply of Terra’s UST, increases the supply of newly-minted LUNA, and then that props up the peg.

When UST is worth more than a dollar, the traders exchange LUNA for UST, and then some of that LUNA is destroyed, and then there’s newly-minted UST, which increases the supply, and then that brings down the peg.

I purchased about $1,500 of the LUNA-linked crypto token last September as part of my research on Terra. But that peg for Terra USD and the dollar was dependent on participants, traders willing to hold UST and LUNA and exchange one for the other. And if that willingness to do so waned, if traders began to doubt the viability or the value of either token, then the system could crash in what is known as a death spiral. And that is exactly what happened with Terra USD. It was worth a dollar on May 6th, right around the time that Kash was tweeting “In a time of crisis, go to Kash.” On May 9th, the peg started to slip, and Terra USD was worth only 77 cents. At that time, Kash’s Twitter account tweeted “To all users, given the historic nature of today’s events with UST stablecoin, we are unsure of what the UST-USD redemption rate will be. We’re working with PrimeTrust and Fireblocks to figure it out. In order to avoid inadvertent loss of funds, please hold your UST.” Kash is telling its customers not to sell. “Don’t redeem your UST back into US dollars on the Kash app.” That was on May 9th. By May 12th, Terra USD was worth only 5 cents per dollar. A 95% loss.

Back on May 9th, when the peg had fallen to 70 cents, Kash tweeted that it’s a whole new ballgame, and there’s no written contracts for how this will play out. “We just want to watch out for your backs the best we can. This is true DeFi, good and bad.” The story is not as strong. The commitment to this guaranteed 10% interest rate is starting to break.

On May 12th Kash tweeted “Hello, everyone. Given the events this past week, we recommend everyone avoid using the Kash DeFi platform. The Terra ecosystem has collapsed, and we cannot advise it at this time.” And then they included a video.

In the comments of that tweet, Kash continued, “It’s a shame what happened to Terra. The short attackers hurt real people in real ways. We all feel distraught and devastated at Kash DeFi. The Terra ecosystem was amazing but just fell to a black swan event. We had a dream to change the world. It became a nightmare.”

Then they followed up, “Finally, we recommend everyone start to follow the Intellabridge Twitter thread for future updates. We will be migrating away from Kash and moving to an exciting, bold, new future. We love you, and please take care of yourself. Life is a gift.”

That’s ludicrous. Five days earlier Kash is tweeting to us that we can get guaranteed 10% savings with Kash. And in a crisis, people flee to cash, so we should flee to Kash and earn 10%, and tell everyone. Tell all our friends, tell businesses, tell non-profits. Now their entire platform fell to a black swan event, and customers on their app lose essentially all their money?

Black swans are extreme, rare, unpredictable events. This was certainly extreme, but it was also very predictable. Instability is built into the algorithm. It was a bank run. Something that has occurred repeatedly with any private money system. Bank runs are why governments have to offer deposit insurance programs. Bank runs are why the Federal Reserve has to step in and back-stop money market mutual funds, like they have done twice over a 12-year period.

The reality is algorithmic stablecoins haven’t worked. It’s disingenuous to suggest the collapse of Kash and Terra USD was due to short-sellers, that it was a black swan event.

In episode 373 I quoted Dr. Ryan Clements, who was writing for the Wake Forest Law Review, and he said “Algorithmic stablecoins are an unregulated, uncollateralized (there’s nothing backing them) digital asset that operates in a perpetually vulnerable state.” If something is perpetually vulnerable, it can crash. And Clements continues, “And if demand to participate in the ecosystem falls below a threshold level, the entire system will fail.” That is what happens and has happened to algorithmic stablecoins.

In episode 373 I discussed another algorithmic stablecoin, Beanstalk. That stablecoin a few weeks ago also crashed. It became worthless. In that case, a bad actor took advantage of the stablecoin governance mechanism to steal all the beans, the stablecoins and other cryptocurrencies. I won’t go into that in more detail here, but I discussed it in great detail in Plus episode 384.

Now, Terra didn’t go down without a fight. The LUNA Foundation Guard—this is a reserve fund that was set up to back the algorithmic stablecoin in case participants no longer wanted to step in and trade UST for LUNA. Last week that foundation had about 3.5 billion dollars’ worth of Bitcoin. Today it has less than 10 million, because it spent over 3 billion dollars of Bitcoin trying to maintain the peg of Terra USD. But it wasn’t enough.

Earlier this week, Do Kwon, who is Terra’s founder announced a new plan. They’re going to essentially fork the software, break it off, take the existing code and start a new version that doesn’t have an algorithmic stablecoin. They plan on distributing a billion tokens of a new version of LUNA to existing LUNA and Terra USD holders and developers. But the old LUNA, which I held—it’s worthless. As is Terra USD.

Intellabridge is also coming back to the market and launching Kash 2.0 in June 2022. An updated version using Ethereum and Polygon. I have no idea how many customers lost their deposits with Kash. Intellabridge stock has plummeted. It was $1.44 last July; this publicly-traded company, Mastercard-incubated. Today it’s worth 8 cents per share, down from 29 cents per share last week.

Tether Stablecoin Risk

Now, in this debacle even true stablecoins came under pressure, the stablecoins that are backed by collateral. Last week Tether broke the buck and fell to 98 cents, just for a short time. The way that Tether works though is verified customers can redeem the Tether stablecoin for a dollar. So if it falls below a dollar for one Tether, these verified customers can exchange the Tether for a dollar, and that’s exactly what happened.

Last week in one 24-hour period Tether honored over 300 million dollars of redemptions and was processing another two billion dollars on Thursday. They said most of their collateral is in Treasury bills and they’re reducing the amount of commercial paper.

The controversy with Tether is is the collateral there? The reality is Tether has never been audited. Last fall, Tether paid 41 million dollars to the Commodities Futures Trading Commission because they failed to complete routine professional audits, even though they said they did.

Tether just issues attestation reports, verifications from a three-person firm in the Cayman Islands. So we don’t really know if the collateral is there backing this true stablecoin, the largest stablecoin in the world, with over 70 billion dollars outstanding.

Money Principles

Let’s then consider what we can learn from what is going on with these stablecoins and money in general. Here are some money principles that we should never forget. The first is most money is private. The money is an IOU from a private entity. That could be a bank deposit. If you put money in a checking account, you have an IOU from the commercial bank. If you have money in a money market mutual fund, it’s an IOU from a private entity. If you hold a stablecoin, it’s an IOU (if it’s a true stablecoin).

The only somewhat public money is cash. Currency. Bills and coins. Most money, including most private money, is debt backed by debt. Bank deposits are backed by loans. Money market mutual funds are backed by collateral. Treasury bills, commercial paper. True stablecoins are also backed by collateral.

All private money though—and this is point three—is subject to runs. People worry the collateral backing that private money is no good. Or isn’t sufficient. So they demand their money back. And when there’s a run, that potentially can cause the private money to collapse, which is why the most secure private money is guaranteed by public money in order to prevent bank runs. That’s why deposit insurance exists for commercial bank deposits or deposits in credit unions. That private money, which is backed by loans and other assets, is guaranteed by public money, by the government, in order to prevent bank runs.

Prior to FDIC insurance and other deposit programs, bank runs were incredibly common. It’s only because of the public guarantee of that private money that bank runs have subsided.

The fifth point is the safest money has the lowest yields. If a mobile app is promising a 10% stable yield, guaranteed, that should raise some red flags. We should first make sure it’s private money—because it probably is—understand what collateral is backing it (if there is collateral), and who if anyone is providing the guarantee.

Most of these new apps—there are many that are acting like banks. They use language like banks, they try to build their credibility, “Because we’re publicly traded/we’re a thought leader”, they say it’s guaranteed when it’s not. Be very careful when it comes to private money.

Finally, money loses its value due to inflation, due to a lack of trust, if people don’t want to hold it. But if people do want to hold it, just the continued creation of more and more money leads to inflation.

Last week in our email newsletter I announced a free inflation course that we’re offering. It’s an email course that goes over about five days, and if you want to learn more about inflation and protecting against inflation, sign up for this free email course at moneyfortherestofus.com/inflation.

We hold money because we want to spend it, or we intend to spend it, or we want the optionality of deploying it to a future investment. We want that flexibility. We don’t hold money as an investment because money loses its value, and is potentially subject to runs. We invest in order to earn a rate of return greater than the rate of inflation over the long term.

Gold, Land, Water, and Weapons

I got an email a few months ago from a listener, and I keep going back to it because it’s pretty fascinating. He said he would never keep anything in currencies, only enough to survive, maybe six or twelve months of expenses.

He owns gold, mostly bars that he can break off little one-gram pieces, or silver. And the reason is his family lost everything during World War I and World War II. They moved to Brazil 70 to 80 years ago, from Central Europe. In Brazil, they’ve seen seven different fiat currencies as hyperinflation ate into the value of that fiat currency. He said it took his family two generations to build up an asset of rental houses and land.

In Brazil all those people that kept their money in bank accounts—they lost everything due to inflation. His recommendation is gold, silver, ammunition, weapons, and water, for each person in the household. To harvest the land, to own land, to own real things. Something we’ve talked about. Money is used for transactions. Investments are used to maintain our wealth over time. And those investments can be paper investments, but should also be real things—gold, land—that hold their value in a period of high inflation.

Again, you can learn more about inflation in our free inflation course at moneyfortherestofus.com/inflation. Be very wary when it comes to stablecoins.

I still own some stablecoins via BlockFi, but only enough that I’m willing to lose, because what we have seen in this huge drawdown in cryptocurrency—I lost all my money in LUNA, about $1,500. I lost about $800 in Beanstalk. And again, these were small amounts that I was speculating with. But many of these other cryptocurrencies are down 75%. That’s what a speculation is. There’s no cash flow. It all depends on trust. And we’re in a period where people just aren’t trusting money as much, so make sure that the money you hold is backed by collateral and guaranteed by the government if you’re going to hold money. But for most of your assets, hold investments. Real things.

That’s episode 387.

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