Watching Tether

This is a quick post to share some of the things I've learnt from watching Tether over the last two months. I'm hoping other Tether watchers find this information useful and share some of their own Tether watching tricks in the comments section. (No conspiracy theories, please. Just analysis).

There's two sides to watching Tether. You can observe its real-world activity like its attestation reports, press releases, brushes with the law, and its social media accounts. Or you can follow its life on the blockchain, where it issues digital stablecoins. This post focuses on the latter. In particular, I'm going to analyze the blockchain for redemptions: those on-chain transactions in which Tether units move from Tether customers back to Tether itself.

I'm going to assume some basic knowledge of Tether and blockchain analysis.

To understand how Tether works on-chain, the most important wallets to track are Tether's two treasury wallets. Tether's Tron-based treasury wallet is located here, and the Ethereum-based wallet is here. (Tether also issues tokens onto other blockchains, but the amounts are relatively small, so for simplicity's sake I'm going to focus on Ethereum and Tron-based Tether activity.)

All Tether units begin and end their life in Tether's treasury wallets.

They begin life when Tether creates, or mints, new units. As long as they remain in Tether's two treasury wallets, these new units are not yet officially in circulation. Tether tokens only enter circulation when Tether issues them—or transfers them—from its treasury wallet to a customer.

Tether mints new units only rarely, and when it does, in large sizes.

In the 350 days from July 1, 2021 to June 15, 2022, Tether minted 24 times on Tron and 9 times on Ethereum. That's around one minting every ten days.

Tether almost always mints in $1 billion increments. This $1 billion balance gets slowly drawn down as customers submit requests to Tether for small batches of Tether units, often in the $10 million to $100 million range. Effectively, this means that Tether's two treasury wallet usually hold a large multi-million working inventory of non-circulating Tether units.

These balances of freshly-minted non-circulating Tether are regularly augmented by inflows of redeemed Tether units. Redemptions occur when customers transfer their unwanted Tether tokens to Tether's treasury wallet to be redeemed for a wire transfer of regular dollars. Each redemption reduces the quantity of Tether in circulation while increasing the quantity of non-circulating Tether units sitting in Tether's treasury wallets.

In the 350 days from July 1, 2021 to June 15, 2022, I count 432 redemptions (177 Tron, 255 Ethereum). That's an average of over one redemption per day.

Tether doesn't destroy, or burn, each incoming Tether redemption. It waits for a number of redemptions to accumulate in its treasury wallet and then burns them all in one big batch.

In the 350 days from July 2021 to June 15, 2022, I count just 12 burns (11 Tron, 1 Ethereum). The amounts burnt are large, often over 1 billion.

So to summarize, the inventory of Tether tokens held in Tether's treasury wallets is determined by the number of incoming Tether tokens (from occasional mintings and frequent redemptions), and outgoing Tether (from occasional burns and frequent issuance).

I've charted out what this treasury working balance looks like going back to late 2021. Note that the chart combines both Tether's Tron and Ethereum treasury balances.

You can see that in 2021 and early 2022 Tether typically let its treasury wallet balances rise to $2-4 billion before burning them. In May and June 2022 it altered this practice by allowing them to balloon to over $10 billion. (Tether recently burnt 11.1 billion Tether units, bringing its working balance back to more normal levels.)

-----

Having worked out how treasury wallets function, I want to focus a bit more on the redemptions themselves. Of the 432 redemptions that I counted from July 2021 to June 15, 2022, a total of 133, or 31%, come from wallets tagged as being owned by Bitfinex, a cryptocurrency exchange owned by Tether's parent. (26 Tron, 107 Ethereum).

Bitfinex maintains two Ethereum addresses that hold Tether tokens (Bitfinex 2 and Bitfinex 3) and one Tron address.

Why do such a large proportion of transfers sent to Tether's treasury wallet originate from Bitfinex? 

What I believe is happening is that rather than sending redemptions directly to Tether's two treasury wallets, large traders often send them to Bitfinex instead. Once the Tether tokens arrive in Bitfinex's wallet, Bitfinex makes the trader whole by wiring them actual U.S. dollars. So from the trader's perspective, the redemption process is complete. They have cashed out their Tether units.

From Bitfinex's perspective, however, the redemption process is not done. 

Rather than sending traders' redeemed Tether tokens immediately to Tether for cancellation, Bitfinex generally holds them for a period of time. I suspect that Bitfinex delays these transfers so that it can meet incoming requests from traders for new Tether issuance out of its own inventory. A delay also allows Bitfinex to accumulate additional redeemed Tether tokens so that it can send the balance in one convenient end-of-period batch to Tether's treasury rather than multiple small transfers.
 
We have evidence that redemptions are happening via the intermediation of Bitfinex. In a 2021 article. Alameda Research—a crypto trading firms—points to a set of Tether redemptions that it claims to have completed. They were all processed through Bitfinex rather than Tether. (ht @ Matt Ranger)

To get a feel for how Bitfinex manages its Tether balances, I've charted out the quantity of Tether balances held in Bitfinex's #2 wallet below. The chart covers May 1 to June 15, 2022. 

Admittedly, this was an unusual period of time for Tether due to record-high redemptions. (At one point in May it had built a balance of over 1.7 billion Tether units!) In any case, you can see how Bitfinex steadily accumulates Tether tokens as traders redeem Tether units. In the chart, each dot is a transfer into Bitfinex's #2 wallet. Once Bitfinex deems that balance to be large enough, it sends it all back to Tether's Ethereum treasury wallet for cancellation. The large collapses in the chart are when these transfers occur.

If you are interested in investigating Bitfinex's involvement in the redemption process closer, I've noticed that Bitfinex's #2 and #3 Ethereum wallets work together to manage Bitfinex's inventory of Ethereum-based Tether tokens.

The #3 wallets interfaces with the public. When the public wants to withdraw Tether units, Bitfinex sources the Tether units from its #3 wallet. Conversely, when the public makes deposits of Tether units they flow into Bitfinex's #3 wallet. When the balance of the #3 wallet rises above 105 million units, Bitfinex waterfalls all amounts in excess of $105 million into its #2 wallet. The inventory in the #2 wallet builds until it is deemed large enough by Bitfinex to be sent to Tether's treasury. (It's not always that cut and dried. I've seen Bitfinex transfer Tether units out of its #3 wallet to Tether's treasury wallet, thus bypassing the #3 wallet.)

Note that while Bitfinex manages its Ethereum-based Tether units using two wallets, it only uses one for Tron, which makes Tron-based analysis of Tether much more simple.

So let's sum up the on-chain Tether redemption process. There appear to be two routes by which Tether units can be redeemed. Some redemptions get sent directly to one of the Tether treasury wallets. Others get sent to Bitfinex. After a period of accumulating redeemed Tether units, Bitfinex eventually transmits the entire batch to Tether's treasury wallets for cancellation. At this point they fall out of circulation. After a period of time passes the quantity of Tether units sitting in treasury reaches a high enough trigger point that Tether burns it all, leaving its treasury wallets close to empty.

-----

To finish off, I want to provide a quick look at who is doing the redeeming, and why.

From May 12 to June 30, Tether has contracted by almost 17 billion units, or 20%, which means that a massive amount of redemptions have occurred. A single Tron wallet has been responsible for 3.3 billion worth of redemptions alone. We'll call it the 6DNE wallet after the last four digits in its address.

We can surmise why these redemptions have been occurring by looking more closely at 6DNE's transactions. 

Created on May 12, 2022, the 6DNE wallet has made 3.3 billion worth of transfers to Bitfinex in 108 separate deposits (as of June 30). The average deposit size is 30.5 million Tether units. Most of the Tether units that 6DNE acquires are sourced from wallets associated with three major exchanges: Kraken, Binance, and FTX. (It also acquires Tether units from these two wallets, which I suspect are Binance-satellite exchanges.)

Through much of May and June 2022, the U.S. dollar price of Tether units has regularly fallen below $0.999 on major exchanges like FTX and Kraken. Put differently, one Tether unit is worth a little bit less than an actual U.S. dollar. Prior to May 2022, Tether had clung quite closely to $1.00. To illustrate, I've included a chart of the trading price of Tether units in terms of U.S. dollars on FTX:

Tether's fall in price occurred because large amounts of Tether units were being desperately sold on markets like FTX as the crypto-economy deflated. Tether sets a redemption minimum of $100,000, which means that most Tether owners can't directly redeem unwanted Tether units via Tether's treasury wallets. That leaves them with no choice but to sell on exchanges.

This is where arbitrageurs like 6DNE step in. The owner of 6DNE appears to be buying Tether units in large multi-million batches on exchanges like Binance and FTX at prices of $0.9985 or so, and sending them to Bitfinex to be redeemed at $0.999. By harvesting the tiny $0.0005 difference between the purchase and sale price, the owner of 6DNE earns a near risk-free profit.

Arbitrage conducted by traders like 6DNE helps to prevent Tether's price from falling much below $0.9982 or $0.9981 on exchanges like FTX and Binance. This process doesn't work perfectly, though. On May 12 the price of Tether collapsed to 95¢ on major exchanges, as the chart above shows.

Note that I said that the trader is redeeming at $0.999, and not $1. This is because Bitfinex and Tether both charge a 0.1% wire fee. This fee reduces Tether's effective redemption price from $1 to $0.999.

Let's work out an actual trade. If the owner of the 6DNE wallet purchases 30 million Tether units on FTX at $0.9985 and sends them to Bitfinex to be redeemed at $0.999, the trader earns a profit of $15,000 ($0.0005 x 30 million). The owner of 6DNE may have to pay fees to FTX, which will eat into the bottom line. However, if the trader was making liquidity rather than taking it, fees may be zero to negligible. 

6DNE completed 3.3 billion in redemptions, which assuming a profit of $0.0005 per Tether unit translates into around $1.5 million in gains. Not bad for a two month's work.

After 6DNE's Tether units arrive at Bitfinex, Bitfinex holds them for a while and ultimately sends them to Tether's treasury wallet. At this point 6DNE's formerly-owned Tether units are officially out of circulation. And then after a few days or weeks, Tether burns them. They have ceased to exist.

And that, in short, is how and why Tether tokens flow from the market back to their issuer.

---

Update (June 15, 2023): Since I wrote this blog post, Bitfinex has almost entirely stopped using the Bitfinex 3 Ethereum wallet. In its place, it is using this wallet as its hot wallet.

Also, Bitfinex has added an extra Tron wallet to its redemption & withdrawal process:

A note for Tether watchers. Bitfinex is the hub for most Tether redemptions & withdrawals. Last week Bitfinex began to hold a portion of its USDt-Tron in the following untagged address: https://t.co/dZqopPSmoq

Bitfinex's ownership is confirmed here: https://t.co/Vs8kOFDbFB

— John Paul Koning (@jp_koning) November 10, 2022

Thoughts on Tether's $10.5 billion contraction

As the world's largest stablecoin, Tether has attracted its share of critics. There are several strains of Tether criticism.

Under one strain, Tether is a black box used to manipulate the price of bitcoin higher. I've never subscribed to this critique. It seems far-fetched to me, much like the theories about gold price suppression.

Other critics see Tether as a fraud, say like Madoff or Enron. They stress many of Tether's documented past transgressions. They could be right. But I hope they're not, since that would inevitably mean a lot of people getting hurt.

For my part, I'm not a skilled enough financial bloodhound to be able to sniff out fraud. I've generally started from the assumption that the public information that Tether has disclosed, most importantly its attestation reports, is accurate. A stablecoin attestation report is an examination of a stablecoins reserves, or assets, by an external auditor.

Having generally based my analysis of Tether on its assets, that analysis has always suggested that Tether (in its current incarnation) is doomed, at least in the long term. I suppose that this gets me to a similar ending-point as the Tether-as-fraud critics, albeit via a different route.

The stablecoin competitive dynamic is best characterized as a jog to the top (rather than a race to the bottom). Over a long enough period of time, the safest and most transparent issuers will be the winners. Let me explain why.

Because stablecoins don’t pay interest to customers, customers aren’t compensated for bearing the risk of the issuer’s underlying investments. This incentivizes users to migrate towards the stablecoins with the safest investments and most transparency, the good money eventually displacing the not-so-good.

Of the big three stablecoins (Tether, USD Coin, and Binance USD), Tether has always had the riskiest investment profile. As of Tether's last attestation report, for instance, 14.4% of its assets were comprised of an opaque collection of secured loans, other investments, and corporate bonds & funds (see list below). Meanwhile, Tether's competitors USD Coin and Binance USD are currently 100% invested in Treasury bills, cash, and money market funds.

List of Tether's assets from its March 2022 attestation report [pdf]

In addition to a difference in asset quality, I'd argue that USD Coin and Binance USD have better legal protections for users in the event of failure. Binance USD in particular operates under the New York stablecoin regulatory framework, which obliges Binance USD's issuer, Paxos, to operate as a trust. Trusts are effective mechanisms for ring-fencing customer funds from an issuer's other creditors.

Given Tether's outsized allocation to risky assets and fewer protections in the case of insolvency, Tether was always destined to be a victim of a jog to the top. That is, as the riskiest stablecoin it was fated to drip-drip market share to USD Coin and Binance USD until it shrunk into irrelevancy. And that's what has been happening. In the chart below, Tether's dominance has been steadily declining.

(For more on the jog to the top dynamic, I've written about it here, here, and here.)

On May 12, that slow drip turned into a rush, as the chart below shows. For the prior two years Tether had been growing, albeit at a slower rate than its competitors USD Coin and Binance USD. But over the ensuing two weeks, around 10.5 billion Tethers were quickly redeemed, a reduction of 12.6%. Meanwhile, USD Coin and Binance USD grew by around 5 billion units.

The combined value of USD Coin and Binance USD, the safest top-3 stablecoins, is now equal to the value of Tether, the least-safe of the big three stablecoins. pic.twitter.com/yIM3DS4h5s

— John Paul Koning (@jp_koning) June 1, 2022

I'd argue that Tether's May contraction wasn't the product of the slow grinding attrition of a jog to the top. It was something more serious: an old-fashioned bank run. 

What might have brought the run on?

Once again, I blame Tether's weakest-link investments: the 14.4% of Tether's assets allocated to secured loans, other investments, and corporate bonds & funds.

What is the makeup of Tether's other investments? We don't know. Tether has never bothered disclosing these details. We also don't know what sort of collateral Tether has accepted for its secured loans, or the rating of the corporate bonds that it hold, or what kinds of "funds" it owns.

Combine this paucity of information with a big drop in cryptocurrency prices over the previous months, and I suspect that by May 12 financial market participants had begun to fill in the blanks with their own worst-case scenarios. A big enough hit to the value of Tether's other investments, for instance, would have meant that Tether was insolvent: that it didn't have enough assets to meet all redemption requests. (Here are Patrick Mackenzie's efforts, for instance, to run the accounting on Tether's solvency.)

For large Tether owners, there would have been two ways to approach a potential Tether insolvency. One option was to just ignore the problem. As long as everyone else does the same and holds on to their Tethers, then a strange sort of let's-all-pretend equilibrium emerges; Tether's peg holds and no one loses.

The other approach is to redeem now while Tether still has a large but limited supply of Treasuries and can easily meet redemption requests. If everyone else follows this same strategy, a run develops. No one wants to be the last one out, since the only assets remaining to support latecomers' redemption requests would be Tether's questionable assets, the ones potentially wiped-out during the prior crypto price crash. Being the last one out could mean only getting paid 30 or 40 cents per dollar.

The second of these two reactions likely took over on May 12, leading to the 10.5 billion contraction in Tether. Luckily for Tether, the big slide in bitcoin and crypto prices has halted. And with the pessimism surrounding all things crypto having dissipated, the run on Tether seems to have ended, at least for now.

Before another crypto market decline hits, I'm hoping that Tether seizes the opportunity to make a few changes.  

First, Tether should immediately disclose details about the nature and value of its weakest-link assets: its secured loans, other investments, and corporate bonds & funds. By doing so it would reassure the market and break the collective urge to flee Tether come the next big drop in crypto prices. Tether should also begin the process of unwinding and selling-off its weakest-link assets, investing the proceeds in Treasury bills and investment grade commercial paper. Without risky assets, Tether would be relatively immune to big falls in crypto prices, and this in turn would reduce the threat of a run on Tether.

If the value of Tether's weakest-link assets has been impaired, then mere disclosure isn't going reassure anyone. Tether needs to fill the vacuum by raising new funds. That is, it is insolvent and needs to recapitalize itself. If people who hold Tether stablecoins know that there's a load of new cash sitting in Tether coffers, that'll end their urge to get out the next time the crypto market falls.

The good things about these measures is that they won't only put an end to Tether's chances of facing another run. They'd also solve Tether's longer-term problem of being the victim of a jog to the top.

In my worst case scenario, Tether doesn't do any of these things. It doesn't disclose the nature of its weakest-link assets nor does it make any effort to sell them off. Then the crypto market begins another slide. Investors once again rush to make worst-case inferences about Tether's weakest link assets. A run on Tether develops, but much bigger than the run in May.

By then it may be too late for Tether to make any of the changes that would be necessary to stabilize. In a market rout, getting a recapitalization from other crypto firms may be difficult, if not impossible, and there may be no one willing or able to buy Tether's weakest-link investments. Better to fix things now than later.

What to watch for in Tether's upcoming attestation report

[This is a repost of an article I wrote for CoinDesk earlier this week about what to expect from Tether's soon-to-be published quarterly attestation report. Tether's report was published the day after I wrote the article. My initial reaction to the new numbers is here, on Twitter. In brief, it's good to see Tether add more safe treasuries. The bad news is that Tether's murky "other investments" category hardly shrunk.]

What to Watch for in Tether's Upcoming Attestation Report

With the crypto bull market turning into a rout, speculators and investors have been cashing out of stablecoins in droves. Into this chaos, the world’s largest stablecoin issuer – Tether – is about to publish its most important reserve, or attestation, report ever. Here’s why Tether’s upcoming attestation is key and what investors are looking for.

It’s been a difficult few months for stablecoins. According to data from Coin Metrics available at The Block, the total value of the stablecoin market has fallen from $182 billion in April to $154 billion today, a quick 15% reduction.

Most stablecoins have hewed tightly to their peg through the Great Stablecoin Pullback of 2022, including second- and third-ranked USD coin (USDC) and BinanceUSD (BUSD), both U.S.-domiciled. The decline in the values of these stablecoins comes purely from a fall in quantity as people convert stablecoins into actual U.S. dollars. The pegs of large decentralized collateralized stablecoins like DAI and MIM have also held, as people redeem them for underlying collateral like ethereum and USDC.

This shrinking in the quantity of stablecoins is a healthy market reaction. Given that crypto activity has petered off over the last months, fewer stablecoins are needed to grease the rails of the crypto economy. It’s the task of stablecoin issuers to hoover up unwanted stablecoins in order to contract their supply and keep their price locked at $1.

Alas, other stablecoin pegs have completely broken down, most famously terraUSD, an undercollateralized “algorithmic” stablecoin that, at the time of writing, is trading at 9 cents. Several other uncollateralized stablecoins, including neutrino USD and Deus Finance's DEI, have also experienced large deviations from their peg. Kava Network’s USDX recently fell to 80 cents, reportedly due to its exposure to terraUSD backing.

Then there’s tether (USDT), the world's largest stablecoin. The price of tether on large exchanges like Coinbase, Binance, Uniswap and FTX temporarily plunged to 95 cents on March 12. It has since risen back towards $1.

But the price of tether has not quite clawed back to the exact same $1 watermark to which it adhered prior to March 12. It is trading at just under $1 on major centralized exchanges like FTX and Coinbase. On the decentralized stablecoin market Curve, $100,000 USDT can only be converted into $99,851 USDC, a small but notable discount. Also worrisome is the continued unbalancing of Curve’s 3pool, a major source of stablecoin liquidity, with tether now making up for 74% of value locked-in.

All this suggests that there's still too many tether stablecoins in the market, and that the only remedy is additional supply contractions.

Tether has already shrunk dramatically over the last week. After hitting a peak of 83.2 billion USDT in circulation just last week, redemptions have reduced this amount by 11% to 74.2 billion. To repeat, there is nothing unhealthy per se about a supply contraction. The demand for tethers is lower and supply must be reduced to adjust to this demand.

However, more redemptions will be necessary to return tether to its tight $1 peg across all trading venues. Add to this the possibility that the prices of bitcoin, ethereum and other coins may fall further, inducing additional contractions in stablecoins supply, and tether could have another few billion in shrinkage ahead of it.

Is that something tether can handle?

Unfortunately, the Great Stablecoin Pullback of 2022 comes at an inopportune time for tether users. Thanks to issuer Tether’s policy of only publishing reserve reports every 90 days, they face a shortage of timely information about the assets used to back USDT.

When a stablecoin issuer issues stablecoins into the market, it normally keeps a corresponding asset in reserve to secure, or back, the stablecoin’s peg. As redemptions requests arrive, these reserves get used up. Because a stablecoin’s reserves are key to guaranteeing stability, the big, centralized stablecoin issuers have adopted the practice of providing information about their assets. In regularly published attestation reports, an independent auditor is asked to offer assurance about the quantity and composition of reserves backing the stablecoin.

The people behind USDC and BinanceUSD publish monthly attestations. Alas, Tether has the slowest attestation schedule of the bunch, reporting on a quarterly basis. With Tether's March 31 attestation report still not published, investors find themselves having to fall back on Tether's Dec. 31, 2021, report. But that was an eon ago in cryptocurrency time.

There was plenty to like from Tether’s old report. As of Dec. 31, 44% of Tether's $79 billion in assets were held in safe U.S. government-issued Treasury bills. This constitutes a big improvement from previous quarters. For instance, when Tether first began to report its asset composition to the public in early 2021, only 2% of its assets had been placed in Treasury bills while a hefty 50% had been allocated to riskier commercial paper, the rating of this paper not being reported.

The amount of commercial paper Tether holds had been steadily reduced over time, reaching 31% on Dec. 31. And thanks to improved disclosure by Tether, we now know the rating of this paper: most was A-1 or A-2, which qualifies as investment grade.

Another $4.2 billion, or 5%, was invested in safe cash and bank deposits as of Dec. 31.

This combination of safe investments – cash, investment grade commercial paper and Treasury bills – will have been great fodder for meeting the first $9 billion or so in Tether redemptions. It will be invaluable for subsequent waves of redemptions requests, too.

These improvements are the result of an awkward and confrontational dance between Tether executives and so-called “Tether truthers.” To counter critics, the company has been forced to cough up ever more internal data, which has fueled better criticism, which pushed Tether to make follow-up changes like shifting into safer assets like Treasury bills. Tether now has a serviceable front-line defense against redemptions – thanks in no small part to its critics.

But there were problems with Tether’s Dec. 31 attestation, too. The most concerning part was the $5 billion in "other investments," which comprised 7% of Tether’s total assets.

What exactly are these investments? Did their value suffer in the generalized crypto price collapse of the last few months? Unfortunately, we don't know the answers to these questions because Tether doesn't disclose any information about its “other investments.”

Another less-than-stellar contribution to Tether’s Dec. 31 reserve report was the 10% invested in a combination of secured loans ($4.1 billion) and corporate bonds, funds and precious metals ($3.6 billion). Tether provides few details about the quality of these investments.

These are all questions a Tether owner will probably want more clarity on as they watch Tether meet the current round of redemptions. In its upcoming March 31 attestation report, which Tether should be publishing any day now, investors will be looking for some assurance on these issues.

So what would the perfect March 31 attestation report look like?

Ideally, between Dec. 31 and March 31, Tether will have shifted even more of its customers' funds into Treasury bills and cash. One hopes this movement into Treasury bills will have displaced riskier investments, particularly the murky "other investments" category. The safer Tether's assets were going into the Great Stablecoin Pullback of 2022, the more confidence investors can have that USDT’s peg will hold.

Investors will also want to know more about the quality of Tether’s more opaque investment categories. Without clarity, they could start to worry that Tether’s “other investments” or secured loans were impaired during the big drop in crypto prices. These worries, warranted or not, could ignite additional redemptions as Tether holders line up to get dibs on Tether's safest Treasury bill collateral.

In addition to the hoped-for improvements to Tether's investment quality, Tether needs to publish attestations on a more frequent basis in order to remove informational dry spells like the one investors currently find themselves in. Tether once boasted that it leads the industry on transparency. But it’s behind USDC on this front, which provides monthly reports.

Even better would be to copy competitor TrueUSD and go real-time. Can’t sleep on a Saturday night and want to see if your stablecoin is still well backed? TrueUSD provides 24/7 real-time attestations. Stablecoin owners shouldn't have to rely on information from 137 days ago to deal with breaking market conditions.

Let's hope that Tether's attestation comes out soon and dispels any worries. It remains the most important utility in the crypto economy. Everyone is watching.

The vandalization of "bitcoin accepted" signs

[Here's an article I wrote for CoinDesk's recent Payments Week series.]

Why We Need Crypto Payments to Work

Crypto has always held out the promise of a payments revolution. But that revolution never happened.

We're 13 years into the Bitcoin age, and there’s only one store in my neighborhood in downtown Montreal that advertises that it accepts bitcoin. I was passing by that store the other day and noticed that a vandal had crossed out the bright orange ₿ written on the storefront, adding a "non" in protest.

Why? The vandal didn't provide us with more information. But if I had to guess it probably had to do with their opinions on the environmental implications of bitcoin's security method, proof-of-work. Proof-of-work requires huge amounts of electricity, and in an age of global warming there's no place for such an awesome display of energy consumption.

This small example is illustrative of the crypto payments challenge. It's tough enough for crypto to gain acceptance as a payments network. The medium’s inherent volatility and novelty are huge hurdles. Add to that concerns about crypto’s effect on the environment, and getting the payments ball rolling becomes even more of a challenge.

But even normies who don't care about crypto should want it to succeed as a payments medium.

Cash is rapidly disappearing as a payment medium. The big winners are the Visa and MasterCard card oligopolies. Every time someone deserts cash, the card networks get a little more powerful. As consumers we don't often notice the few cents that the card networks extract from us when we pay with our debit or credit cards, but it leads to fantastic profits for them. Visa and MasterCard's returns on equity – 40% and 120% respectively – give testament to their wide oligopolistic moats. (The average company's return is a meager 10-15%).

There are a number of solutions to oligopolies, one of them being competition. If there are more payment networks fighting for market share, we consumers (and the retailers we frequent) can at least choose the cheapest one.

And that's why it would be nice if crypto worked for payments.

Alas, crypto usage has been mostly confined to the relatively small confines of the speculative crypto economy, only leaking out once in a while to serve as a normie payments medium. These leaks may be slowly plugging up, too. Over the last year or so, activists have been trying to push the small advance that crypto has achieved in the payments realm into retreat.

My neighborhood store is just one example. The storekeeper's internal dialogue might have gone after seeing their store window vandalized: "Why bother accepting the odd bitcoin payment when it attracts such negative attention?"

Last month, hundreds of long-time Wikipedia editors asked the Wikimedia Foundation to stop accepting cryptocurrency, the most popular reason put forth being its environmental sustainability. A few months before, Discord – a popular messaging platform – quashed rumors of a cryptocurrency integration after pushback from users concerned over energy use.

The Wikipedia editors' vehemence stands in contrast to the tiny amount of crypto that Wikimedia has collected. According to Wikimedia, just 0.08% of its donations have been in crypto, mostly bitcoin. The Wikimedia Foundation has little reason to say no to the activists. At 0.08%, crypto isn't proving to be very useful for accepting payments. Why bother pushing back?

Had the activists campaigned for Wikimedia to stop accepting Visa, for instance, it'd be a complete non-starter. Visa has an advantage over crypto. It’s already big, likely accounting for a decisive percentage of Wikimedia donations.

That you can’t say no to Visa, but you can say no to crypto, illustrates the crypto payments dilemma. Retail payments networks are notoriously difficult to bootstrap. It's the classic chicken-and-egg problem. For an individual to adopt it, a new payment option needs to be already useful (by being widely available and spendable at shops), but it can't be already useful if no one wants to try it in the first place.

Making this paradox worse is that the card networks already have firm footholds. People have grown used to their plastic, and the incumbents use dirty tricks to enforce lock-in, like card reward points and no-surcharge policies. The nut is made even harder to break by crypto's incredible volatility. Risk-averse new users are reluctant to try it.

But the crypto world has evolved a response to volatility. Stablecoins are a type of cryptocurrency that is pegged to traditional fiat money, which makes them less intimidating for people to use. And so where regular crypto comes short, stablecoins at least stand a fighting chance against the MasterCard and Visa oligopolies.

Unfortunately, stablecoins are built on energy-intensive proof-of-work blockchains, which opens them up to the growing environmental critique. Given the already difficult chicken-egg payments problem being faced by stablecoin issuers, the last thing they need is for card users to come up with one more excuse not to give stablecoins a try.

Mozilla's recent reappraisal of its crypto acceptance policy provides a good example of how I hope the debate evolves. In January, Mozilla – the nonprofit organization that makes the Firefox web browser – decided to temporarily pause cryptocurrency donations to see how crypto "fits with our climate goals."

This month Mozilla announced its new policy. Rather than closing the door on crypto, it came up with a more nuanced solution. Mozilla won’t accept proof-of-work coins, but it'll accept proof-of-stake cryptocurrencies it sees as "less energy intensive."

If Mozilla's more welcoming policy is emulated, and one hopes it is, it offers stablecoin issuers a window. But this window comes at a price. If stablecoins are ever going to compete in a meaningful way with the card networks, they need to dissociate themselves from proof-of-work. That may mean avoiding expansion to proof-of-work blockchains. At the worst, it means helplessly waiting while the proof-of-work chains on which they already exist, like Ethereum, switch over to less energy intensive security methods.

Removing as much ammunition as possible from critics will make the already difficult chicken-and-egg payments problem a little easier for stablecoins to solve. We need them to win, though. Visa and MasterCard aren't getting any less dominant.

A quick note on Tether redemptions during the current crypto bloodbath

The stablecoin market is currently weathering a crypto bloodbath, with some stablecoins doing a better job of holding their pegs than others. One odd thing I've noticed is that the supply of Tether stablecoins, by far the largest stablecoin, doesn't seem to be contracting. Tether's Ethereum address indicates that there are 39.8 billion Tethers outstanding, the same as in December 2021.

The situation at Tether's main competitor, USD Coin, suggests that this shouldn't be so. The supply of USD Coins is shrinking rapidly. There were around 48 billion USD Coins in existence (on Ethereum) in late February, at its peak. Now there are just 42.8 billion. That's an 11% contraction.

To get a better idea for how the supplies of the two stablecoins are acting differently, check out the chart below. USD Coin (USDC) is the green line and Tether (USDT) is the red line. (Note: this is the amount outstanding on the Ethereum blockchain. Both stablecoins also exist on other blockchains).

 

USD Coin's contraction is consistent with a crypto recession. People want to get the hell out of the cryptoeconomy. They're hurting and they're scared. To support a lower level of crypto speculation, the market doesn't require as much stablecoins as before. So USD Coin has to shrink to accommodate this reduction in demand. That's normal.

But the implication is that Tether should also be contracting. After all, it's not exempt from the broad forces hitting USD Coin. There shouldn't still be the same 39.8 billion Tethers circulating in what is now a much smaller crypto economy.

What I'm guessing may explain some of this divergence is different redemption policies among stablecoin issuers. When Circle, the issuer of USD Coin, redeems USD Coins with U.S. dollars, it simultaneously destroys those coins. And so any redemption directly reduces the total quantity of USD Coins in existence. It may be that Tether doesn't actually destroy the Tethers that it redeems. It first confines them to its treasury wallet. And so redemption don't immediately reduce the total quantity of Tethers in existence. Rather, it impounds the redeemed Tethers.

So what is happening with Tether's treasury wallet? Check out the chart below:

Since late February, the amount of Tether stablecoins sitting in Tether's treasury has increased from around $800 million to $2.5 billion. This is being driven by incoming Tether stablecoins, some of it from exchanges like Bitfinex and FTX. So given that Tether has impounded $1.7 billion Tethers over the last few months, the total circulating supply of Tether has concomitantly decreased by $1.7 billion, most of that in the last few days.

This suggests that Tether is in a contraction phase, just like USD Coin. But Tether's contraction is more muted, at least for now. USD Coin has shrunk by 11%. Using the quantity of Tethers in Tether's treasury wallet as our measure, Tether has contracted by only 4%.

---

P.S. I've limited my analysis to the Ethereum blockchain. Someone with more time could extend my analysis to the Tron blockchain, since there are significant amounts of both Tether and USD Coin on Tron.

P.P.S. One thing I'm not sure of is how much redeemed Tethers are held by Tether in temporary wallets that aren't its main treasury wallet. If that number is high, then Tether's contraction is further along than my blog post suggests.

The tragedy of Dogecoin

Dogecoin is currently using as much electricity as the entire state of Vermont, home to 620,000 people, tens of thousands of businesses, hundreds of schools and dozens of hospitals.

This constitutes a tragedy. Here's why.

Dogecoin is a dog-themed cryptocurrency that was introduced in 2013 as a joke. The total quantity of Dogecoins has jumped to $80 billion in value by 2021, although it has since fallen back to $15 billion.

Dogecoin functions primarily as a gambling tool. If people get the timing of their Doge purchases right, they can make life-changing profits in a very short period of time, no leverage required. There are also certain cultural and aesthetic reasons for holding Dogecoins. It's a meme. An icon. For long-time crypto veterans, Doge is a badge of their insiderness. It shows that they're in on the joke.

But why does it cost a Vermont's-worth of electricity – currently 5.5 terawatt-hours – to produce the Doge gambling experience and assorted Doge cultural material? After all, Vegas casinos provide far more of this sort of entertainment... at a fraction of Doge's total electricity cost.  

What I'd suggest is happening here is a type of market failure. Doge is hugely expensive to run. (That's because it uses an energy intensive security method called proof-of-work, which you can read about here). But the casual gamblers and pop cultural aficionados who gravitate to Doge doesn't absorb any of Doge's costs. That is, they don't feel the expenses incurred to run the system. And so they over-gamble on Doge and overindulge on Doge memes. Put differently, the market is accidentally overproducing Dogecoin services.

Dogecoin owners don't feel the painful costs of running Doge because of mining rewards. Each minute, 10,000 new Dogecoins are created out of thin air and paid out to the agents (known as miners) that secure the Doge network.

These mining rewards don't come out of a Doge owner's personal wallet. So if you own some Doge, you never directly experience the costs of running the Doge system. Courtesy of the reward system, you're shielded. Both your Doge gambling habit and your imbibing of the Doge cultural experience are subsidized.

If a casino were to suck up Doge levels of electricity, customers would immediately feel these costs. The nightly rate for a hotel room would be epic, the vig would be huge, and it'd cost $10,000 to go see Celine Dion. This very expensive casino would rapidly go bankrupt. 

But not Dogecoin. By using mining rewards to pay for electricity, Dogecoin escapes the casino's fate.

You'd think that Dogecoin owners might at least feel the pain of 10,000 new Dogecoins being created every minute to pay for electricity costs. After all, the miners who receive this reward need to sell those coins to meet expenses like salary and utility bills. Their continual selling should put pressure on Doge's price, and this constant pressure would hurt Doge owners, sort of like a casino room bill.

Not so. The entire stream of 10,000 Doge rewards is known ahead of time. The market therefore factors all future mining-related sales into Doge's current price. So if you own some Dogecoin you never experience anything akin to "sell pressure." It's already priced in. You get to consume Dogecoin as-if it was free.

And that's why Dogecoin constitutes a tragedy. Doge burns up Vermont-levels of electricity because, unlike a regular casino, there is nothing to stop it from doing so. Without a natural cost brake, users consume as much Dogecoin services as they want. If Doge owners did have to bear the true costs of Doge security, they'd quickly find a cheaper venue to gamble, and a thriftier source for meme culture. A Vermont's-worth of electricity would be saved.

Thoughts on the relationship between corruption and crypto adoption

[This is a re-post of an article I wrote for CoinDesk last week. The IMF recently found that corrupt countries tend to have high crypto adoption. In my article I suggest that this is because citizens of undeveloped countries are using crypto to dodge broken institutions controlled by corrupt elites. I cite Cuban crypto remittances as an example of this. But we shouldn't idealize crypto as a tool for emancipation. A big chunk of crypto usage is unproductive. Their corrupt institutions crushing them, people in undeveloped nations see in frenetic crypto prices a potential escape, a last-chance financial gamble. But this escape is illusory. Undeveloped nations require genuine institutional change, not more gambling opportunities.]

Don't Blame Crypto for Corruption
An IMF study suggesting crypto is facilitating corruption is off target via CoinDesk

Is crypto fueling corruption? The International Monetary Fund (IMF) seems to think so. Using crypto usage data from Statista’s Global Consumer Survey, a group of IMF researchers recently found that countries with high crypto adoption tend to be perceived as corrupt.

As to why this relationship exists, the IMF team suggests that crypto is being “used to transfer corruption proceeds." With crypto facilitating corruption, their advice is the product needs to be regulated, the idea being that regulation – especially know-your-customer requirements – will end graft.

The IMF has this one backwards. Crypto doesn't fuel corruption. Rather, whatever underlying malaise is fueling corruption is probably also fueling crypto adoption.

Why Nations Fail

In "Why Nations Fail: The Origins of Power, Prosperity, and Poverty," economists Daron Acemoglu and James Robinson offer an explanation for why some nations seem to function well and are relatively free of corruption, like Canada and Sweden, and others do not, like Nigeria and Syria.

It isn't geography or culture that determines success, say the authors, but institutions. By institutions they mean the rules that govern and shape economic and political life: property rights, contract enforcement, licensing standards, financial regulation and more.

Inclusive institutions create the incentives necessary to harness the energy and entrepreneurship of all members of society. Extractive institutions do the opposite. They create a non-level playing field and narrowly concentrate access and benefits for those with political power.

Acemoglu and Robinson offer the city of Nogales, which straddles the U.S.-Mexico border, as an example. “The inhabitants of Nogales Arizona, and Nogales Sonora share ancestors, enjoy the same food and the same music, and … have the same culture,” write the authors. But those on the northern side are prosperous while those on the south suffer from poverty. They suggest this is because U.S. institutions are more inclusive than Mexican ones.

Under Acemoglu and Robinson’s framework, corruption is a by-product, or symptom, of extractive institutions. A profusion of bribes is the return flowing to the small set of politicians, bureaucrats and soldiers who have managed to seize control of a country’s gears.

Regulating crypto is important but it won't fix corruption

Which returns us to crypto. Solving a problem like corruption requires the tearing down of underlying institutions that abet the graft-addicted elites, and their replacement with institutions that actually work for the people. The IMF's prescription for fixing corruption – crypto regulation – is just a cosmetic change. It does nothing to alter the sick institutions driving corruption, poverty and inequality.

If the IMF's prescription is inadequate, I’d suggest that its explanation for the correlation between crypto and corruption is wrong, too.

Instead of crypto fueling corruption, as the IMF seems to think, it's the other way around; the very same extractive institutions that drive corruption are fueling crypto usage. Put differently, the reason we see high rates of crypto adoption in undeveloped nations where elites rig the rules of the game is not because those elites are dealing in crypto bribes, but because the suffering masses see crypto as a form of escape.

Why do people adopt crypto as a reaction to bad institutions? There are two opposing camps. I'll call them crypto-as-redemption and crypto-as-tragedy.

Crypto-as-redemption

For advocates of the crypto-as-redemption viewpoint, the correlation between corruption and crypto adoption is a sign that crypto is acting as a redeeming force. Citizens in corrupt countries are using it as a hack around the extractive institutions that subjugate them.

Take Cuba for instance, a country long bedeviled by extractive institutions. Most Cubans lack connections to the ruling regime. This makes it very difficult to make ends meet, and so they are reliant on remittances from Cuban family members living in the U.S.

But the regime extracts its pound of flesh. Remittances made through Western Union have historically been routed through a set of Cuban-military linked financial companies, which take a cut of around 5%-10% of each remittance for themselves. By avoiding the regime’s intermediaries, crypto provides Cubans with the chance to get better exchange rates.

Crypto also offers a route when those intermediaries cease working altogether. In 2020, the Trump U.S. presidential administration placed sanctions on the military-linked companies involved in remittances, making it difficult for Cubans to send in dollars at all. Some Cuban-Americans turned to couriers, or "mulas," to physically transport cash to relatives. Others used banks in Europe, which were still willing to interact with non-sanctioned Cuban banks.

Crypto emerged as one of these alternative remittance channels. With Western Union down, Cuban Americans could send crypto directly to their relatives who converted it into Cuban currency to buy food and pay bills. For Cuban recipients who don’t want to handle crypto directly, tools like BitRemesas allow local traders to bid for the right to deliver these remittances in person as cash or to their bank account.

And thus crypto became a redemptive force in Cuba, helping fill in the cracks when institutions stop working for people.

Crytpo-as-tragedy

The crypto-as-tragedy view takes the opposite view. Most developing nations' crypto usage isn't very redemptive at all. Instead, crypto is a last-gasp gambling venue for the desperate.

Take the case of Nigeria, a country beset by extractive institutions and corruption. Citizens who want to advance in life have fewer options than in the West. They are excluded from many of the official channels that lead to financial advancement: gainful employment, genuine business opportunities and investment. Desperate, they've turned to the only available channel for advancement: get-rich schemes, Ponzis and hyper-volatile crypto.

According to Statista crypto adoption data, Nigerians are the most likely of all nationalities to say they used or owned cryptocurrency. Nigeria also happens to be the world capital of the Ponzi scheme. Starting with MMM in 2016, waves of Ponzis have torn through the country including Ultimate Cycler, Icharity Club Nigeria, Get Help World Wide, Givers Forum, Twinkas, Crowd Rising and Loom.

Surveys show that more than half of Nigerians have either participated in a Ponzi or know someone who has. Many are unemployed students, which isn't surprising given Nigeria's 33% unemployment rate. In one survey of Nigerian Ponzi investors, 60.3% cited harsh economic conditions as their reason for joining Ponzi schemes.

For a young Nigerian with few prospects for advancement, a cryptocurrency that promises to moon by 100 times serves the same purpose as a Ponzi scheme like MMM.

If Nigeria’s failed institutions are driving a culture of long-shot financial bets, these bets aren't genuine escapes. Volatile zero-sum games allow citizens to temporarily dissipate their desire to escape their lot in life, but they don't create any real economic value. The elites that control institutions in undeveloped nations may even welcome these sorts of financial games. Not only do they not threaten their control over national resources – they may also distract people from their plight.

And that's why crypto usage is tragic. It is a symptom of an underlying sickness. But just as Nigeria’s Ponzi schemes do nothing to solve the actual problem, neither does its rampant crypto speculation.

Which view is correct, crypto-as-redemption or crypto-as-tragedy?

Both crypto-as-redemption and crypto-as-tragedy counter the simplistic IMF connection between crypto and corruption, suggesting a deeper explanation for the relationship.

Both stories are accurate, to a degree. There are some neat non-speculative crypto use cases where the stuff is being used as a life hack to help those living in dysfunctional nations, such as the example of Cuban crypto remittances. At the same time, a big chunk of developing nation usage involves crypto serving as the focal point for the gambling impulses of the downtrodden, not as a useful life hack or an agent of change.

In its purest form, the crypto-as-redemption view elevates crypto to more than just a personal hack for those coping with bad institutions. Crypto is a peaceful revolution. It sneaks in like a Trojan horse and destroys the extractive institutions that bedevil less-developed nations, setting them free.

While crypto can certainly be a good life hack, this hyper-idealization of crypto is dangerous. It gives people the mistaken idea that a product that serves their gambling instinct can somehow solve the developing world's problems.

To reform the institutions that keep citizens of poor nations, crypto won’t cut it. Deep change requires real work.

Where are the customers' rate increases?

U.S. banks are at it again. Inflation is at its highest level in decades. At the same time, interest rates on deposits at the Fed, Treasury bills, bonds and mortgages are rising rapidly to compensate. Yet banks are still in a holding pattern when it comes to the interest rates they pay to customers on savings accounts, certificates of deposit (CDs), and interest-checking accounts.

Here's the chart, which uses FDIC data from FRED. Note how customer deposit rates (in red) have hardly budged, despite the Fed beginning to raise rates last summer. This same sluggishness also occurred in 2015, the last time the Fed began to hike rates. Banks didn't boost savings accounts rates till two years later, in 2017!

 

Historically, rates on CDs seem a little more responsive. But they're still sluggish. The average 6-month CD still only yields a scrawny 0.09%, whereas the yield on a 6-month Treasury bill is now at 1.4%.

This stickiness wouldn't be such a big deal if banks were also slow to reduce interest rates on customers' accounts – win some, lose some, right? But take a look at what happened when the Fed began to cut rates in mid-2019. Banks didn't hold off. They immediately started to pass lower rates on to their customers, and only became more aggressive when COVID hit in March 2020.

So for bank depositors, it's all lose. U.S. banks are slow to increase rates on checking accounts, CDs, and savings accounts, but quick to reduce them. I wrote about this sad lack of symmetry back in 2020. Do go back and read it.

This observation isn't something that economists have ignored. In a paper entitled "Sticky Deposits", Federal Reserve economists John Driscoll & Ruth Judson found that rates are "downwards-flexible and upwards-sticky." This stickiness has consequences for regular Americans. If rate stickiness didn't exist, the authors estimate that U.S. depositors would have received as much as $100 billion more in interest per year!

A sound debasement

An imitation English half noble issued by Philip the Bold, Duke of Burgundy, 1384-1404 [source]

[This is a republication of an article I originally wrote for the Sound Money Project. When we look back at old coinage systems, our knee-jerk reaction to the periodic debasements that these systems experienced is "ew, that's gross." But things were considerably more complex than that. This article tells the story of a healthy, or wise, coin debasement — Henry IV's debasement of the gold noble during the so-called "war of the gold nobles" between England and Burgundy in the late 1300s and early 1400s.]

A Sound Debasement

In his excellent article on medieval coinage, Eric Tymoigne makes the seemingly paradoxical claim that “debasements helped preserve a healthy monetary system.” A debasement of the coinage was the intentional reduction in the gold or silver content of a coin by the monarch by diminishing either the coin’s weight or its fineness. I’m going to second Tymoigne’s paradoxical statement and provide a specific example of how a debasement might have been a sound monetary decision.

First, we need to review the basics of medieval coinage. In medieval times, any member of the public could bring raw silver or gold to the monarch’s mint to be coined. If a merchant brought a pound of silver bullion to the mint, this silver would be combined with base metals like copper to provide strength and from this mix a fixed quantity of fresh pennies — say 40 — would be produced. These 40 pennies would contain a little less than a pound of silver since the monarch extracted a fee for the mint’s efforts.

The merchant could then spend these 40 new pennies into circulation. Coins were generally accepted by tale, or at their face value, rather than by weight. Shopkeepers simply looked at the markings on the face of the coin to verify its authenticity rather than laboriously weighing and assaying it. This was the whole point of having a system of coinage, after all: to speed up the process of transacting.

As long as the monarch of the realm continued to mint the same fixed quantity of coins from a given weight of silver or gold, the standard would remain undebased. Sometimes, however, “coin wars” erupted between monarchs of different realms, the aggressors minting inferior copies of their victims’ coins. Since these wars hurt the domestic monetary system of the victim, some sort of response was necessary. One of the best lines of defense against an aggressive counterfeiter was a debasement.

John Munro, an expert in medieval coinage, recounts the story of the “war of the gold nobles,” a coin war that broke out in 1388 when the Flemish Duke Philip the Bold began to mint decent imitations of the English gold noble. Flanders, comprising parts of modern-day Belgium and northern France, was a major center of trade and commerce on the Continent. Both the weight and fineness of Philip’s imitations were less than those of the original English noble. According to Munro’s calculations, by bringing a marc de Troyes of gold (1 marc de Troyes = 244.753 grams) to Philip’s mint in Bruges, a member of the public could get 31.163 counterfeit nobles. But if that same amount of gold were brought to the London mint, it would be coined into just 30.951 English nobles. Given that more Flemish nobles were cut from the same marc of gold than English nobles, each Flemish noble contained a little bit less of the yellow metal.

Philip’s “bad” nobles soon began pushing out “good” English nobles, an instance of Gresham’s law. Given Philip’s offer to produce more nobles from a given amount of raw gold, it made a lot of sense for merchants to ship fine gold across the English Channel to Philip’s mints in Bruges and Ghent rather than bringing it to the London mint. After all, any merchant who did so got an extra 0.212 nobles for 244.753 grams of the gold they owned. By bringing the fakes back to England, merchants could buy around 1 percent more goods and services than they otherwise could. After all, Philip the Bold’s fake nobles were indistinguishable from real ones, so English shopkeepers accepted them at the same rate as legitimate coins. English nobles steadily disappeared as they were hoarded, melted down, or exported. Why spend a “good” coin — one that has more gold in it — when you can buy the exact same amount of goods with a lookalike that has less gold in it?

Philip’s motivation for starting the war of the gold nobles was profit. By creating a decent knock-off of the English noble that had less gold in it, though not noticeably so, Philip provided a financial incentive for merchants to bring gold to his mints rather than competing English mints. Like all monarchs, Philip charged a toll on the amount of physical precious metals passing through his mints. So as throughput increased, so did his revenues.

The health of the English monetary system deteriorated thanks to the coin war. With a mixture of similar but non-fungible coins in circulation, there would have been an erosion in the degree of trust the public had in the ability of a given noble to serve as a faithful representation of the official unit of account. Nor was the system fair, given that one part of the population (people who had enough resources to access fake coins) profited off the other part (people who did not have access). Finally, when Gresham’s law hits, crippling coin shortages can appear as the good coin is rapidly removed but bad coins can’t fill the vacuum fast enough.

The English king’s efforts to ban Philip’s nobles had little effect. After all, gold coins have high value-to-weight ratios and are easy to smuggle. One line of defense remained: a debasement. In 1411, some 20 years after Philip the Bold had launched his first counterfeit, King Henry IV of England announced a reduction in the weight — and thus the gold content — of the English noble. This finally resolved the war of the nobles, says Munro. By reducing the noble’s gold content so that it was more in line with the gold content of the Flemish fakes, the English noble lost its “good” status. Merchants no longer had an incentive to visit Philip’s mints to get counterfeits, and English nobles once again circulated. The health of the English coinage system improved.

We shouldn’t assume that all medieval debasements constituted good monetary policy. There were many coin debasements that were purely selfish efforts designed to provide the monarch with profits, often to fight petty wars with other monarchs. These selfish debasements hurt the coinage system since they reduced the capacity of coins to serve as trustworthy measuring sticks. As Munro points out, each medieval debasement needs to be analyzed separately to determine whether it was an attempt to salvage the monetary system or an attempt to profit.