Wall Street veteran Caitlin Long discusses financialization

Wall Street veteran Caitlin Long discusses the sixth network effect of financialization with Wall Street and institutional investors.


ICE announcement

Dr. Vieira 2008 GATA speech

Robert Landis 2005 GATA speech Part 1

Robert Landis 2005 GATA speech Part 2

Fischer v. City of Dover 131 N.H. 469, 554 A.2d 1293 (1989)

Is Financialization A Double-Edged Sword For Bitcoin And Cryptocurrencies? by Caitlin Long

ICE Creating New Cryptocurrency Market: A Double-Edged Sword by Caitlin Long

RepoWatch – a great site that’s highly critical of rehypothecation and has many resources to learn how it works


TRACE:                      Warning: to mildly comprehend this interview may take many hours.  The show notes will contain about 15 hours with the background homework and you may want to listen to this episode at least 3 to 5 times.  Listener discretion is advised.  Welcome back to the Bitcoin podcast.  We have an incredible interview today with Caitlin Long, a Wall Street legend, right, and so welcome to the Podcast, Caitlin.

CAITLIN:                   Oh, thanks Trace.  That's legend overstates the case but you and I have known each other for years and it's really, really an honor to be on your show.  Thank you.

TRACE:                      Well, I mean, tell us a little bit about your background?  You started in Wyoming, went to big old Harvard Law School then went to Wall Street.  One of the few women that has reached such a magnificent stature at Wall Street, you know, spent 22 years there, maybe you could talk a little bit about your background, what you did, how you found yourself there?

CAITLIN:                   Oh, gosh!  Well, I walked out of Harvard with more student loans than my parents' house was worth so I kind of sold myself to the highest bidder which was Wall Street at the time, and that I loved it and stayed 22 years.  I did a lot of different things, worked for a stats directly for the Co-CEOs at Credit Suisse in Zurich.  Most recently ran the pension solutions business at Morgan Stanley.  That's what I did after the financial crisis and that enabled me to get a really good look into the plumbing of multiple assets on Wall Street.  I sat in the capital markets area so worked mostly on issuance but really got into the plumbing of how assets move within Wall Street and learned and I was able to apply that the concepts of Bitcoin and blockchain to that knowledge once I discovered Bitcoin and blockchain.

TRACE:                      Now, I mean, you're talking about like with G.M. for example, transfer worth like $26 billion of assets and I mean there's just a lot that can go wrong.  In that case, right, you got heart shot risk, you've got the risk of bank failure before close, you've got counter party risk, you've got all these little i's to dot and t's across which, you know, as a lawyer you're like you're next on the hook for this, right.  So maybe you could talk a little bit more about, you know, just a little bit of the worst stories from that area of work?

CAITLIN:                   Well, I think one of the interesting worst stories that you and I've talked about before is in that first big pension transaction, these pension deals were transferring assets and liabilities of a corporate pension plan over to an insurance company.  And they had to be done in today, you couldn't have a single asset not make it from the pension fund to the insurance company otherwise the contract wasn't legal.  So we spent weeks defining procedures to ensure that those assets, all which transferred on different rails, ended up in the right place and we didn't have a fail transaction.  And we practiced it and it turns out we actually in the first one we even did some of it in the middle of the night to avoid congestion on the rails and ensure that we had precision on the pricing.  But the best worst story was our discussion of what cash meant.  We were transferring so much cash that the worst at first were, I asked the question what do you mean cash?  Do you mean loading up thousands of (Inaudible 00:04:13) trucks because we were transferring three-and-a-half to four-and-a-half billion dollars of cash.  And I wanted to know that they want a fat wire and, you know, how are we going to deal with a wire of that size.  We had to make sure that all of the approvals were in place to be able to transfer that cash into a day and make sure that it got from the sender to the receiver without any hiccups because a single hiccup would make the whole transaction fall apart.  And luckily, you know, because we pay that much attention, the detail, it all worked, and we created a whole market.  They are proud of that market.  We have a lot of pensioners who now have overfunded pension plans with the risk assets that are actually, have a much higher probability of getting a pension paid and the old corporate pensions, very proud of that.  But boy, did I learn a lot of the muckiness of the operations of the financial industry and just how inefficient it is.

TRACE:                      Yeah, I mean, it's just absolutely technology and software.  So like when 2007/2008 hit, how did that send you down the rabbit hole were you eventually found yourself into this blockchain space?

CAITLIN:                   Well, I knew that the main stream explanation for the financial crisis was lacking.  And there was a contradiction.  I heard Secretary Tim Geithner, the Treasury Secretary at the time give an interview on Charlie Rose where he said he admitted that interest rates had been held too low before the financial crisis.  And that was a direct contradiction to what he had said previously and he furthermore advised the Fed, argued that interest rates should be lowered still.  So that was the contradiction.  Wait a minute, if interest rates were too low going into the crisis and now we're saying we have to lower interest rates even more.  That wasn't logical to me and that's what got me going down the rabbit hole.  And looking at all the whole gamut of alternative economics because it was clear to me what I learned in school was not how the real world worked.

TRACE:                      And so like what Beacon did you hone in on?

CAITLIN:                   Actually, a good friend of mine from a big hedge fund who had been a client many years before we stayed in touch ever since.  One of the smarter guys is we're connected to the flow of information, if you will, than I was.  I asked him for help.  I said that, look, it's very clear the Fed is at the center of this problem and I didn't know how the Fed worked and I wanted his advice on how to go learn and he advised me to start reading the Mises Daily mail and that I'd I figured it out and he was right.

TRACE:                      Well, isn't that helpful.  Now, you know, it's kind of beyond the scope of this interview.  The gold price suppression scheme and a lot of the work that get us done.  But when we look at the solidity in terms of our financial system, could you perhaps explain a little bit about the difference between a debt-based monetary system and an equity-based monetary system and then some of the worst stories that are perhaps come of that.  I know you've have written about the Dole Foods case and some others.

CAITLIN:                   Yeah, sure.  An equity-based asset is nobody's IOU.  There's no counterparty, it's -- you own it outright.  So examples of equity-based assets are of course Bitcoin.  There is no issuer, right, there's no counterparty.  Gold, silver, all commodities, all real assets, real property, land, even your personal property, your car, you can own it outright.  There is no issuer.  It's not an IOU owed to you by someone, but debt-based assets are always IOUs, owed to you by someone and that someone might not make good on their promise, they might default.  And it turns out that pretty much every single financial asset is a debt-based asset.  And the mind bender here is that even the dollars in your wallet are debt-based assets.  If you pull out your dollar bill and if you bother to carry your wallet anymore but it does actually say on it Federal Reserve Note it is an IOU from the Federal Reserve which is the only bank in the United State that has the ability to write IOUs on itself, but technically all financial assets including securities are IOUs.  And what's interesting is that the real assets -- well, I actually have to clarify that.  If you own your securities in paper certificate form, then you own them outright, they aren't an equity-based asset, but most securities based to the SECR not issued in that form anymore and we're all consequently forced into owning them in the form of IOUs.  Every asset in a brokerage account, every deposit in a bank account is a IOU.  And a lot of folks don't realize that.  Well, we don't own the real thing, we own an IOU from a leverage counterparty who owns an IOU from someone else and there may be a default somewhere along that chain.  And at the center of the banking system is of course the Fed which is the issuer of the IOUs at the center of the security's market is a company called the Depository Trust Company which is the issuer of the IOUs.

TRACE:                      So when we're -- and even a little bit further back.  When we're talking about this interest rates, the Fed, you know, Alan Greenspan, he testified twice before Congress that Central Bank's, Pearl stand ready to lease gold should the price rise.  And so it's very odd behavior.  If you own a lot of something why run a cartel to keep the price down.  And it helps, of course their power to issue currency is infinitely more valuable than the price of a portfolio asset.  And so what effect does all of this hypothecation and rehypothecation have when it comes to interest rates and the pricing of assets on a global scale?

CAITLIN:                   Well, we can suppresses them, generally speaking, you know, it can't in a short term have a positive effect because it does create liquidity and liquidity begets liquidity so generally speaking liquidity is positive, but if the liquidity is coming from unbacked the creation of unbacked claims to the assets, then it's not healthy and it actually creates lack of scarcity where there was scarcity before.  So I know you like to talk about the gold market.  That's a perfect example.  There's physical scarcity to physical real-world gold.  But if you create paper claims to gold there is no scarcity to those paper claims.  And therefore, you can't actually offset the real-world scarcity of the asset by creating unbaked paper claims that have no connectivity to the real underlying asset.  And that's what happens in a Wall Street in a lot of different ways, they called it different things.  They called it securities landing, they called it rehypothecation, they called it stock loan but it's always the same thing.  You're taking an asset and lending it out.  And the crazy thing about the way the accounting works for that is that both parties that the original owner and the one that borrowed it get to report it on their financial statements as if they both own that asset but there's really only one asset.

TRACE:                      You know, one of my favorite parts of that accounting is the cash flow statement.  And you had very fascinating question like what is cash.  And if we start applying this to internet protocols to cyberpunk terminology we have Nick Szabo and Dr. Adam Back and they both kind of have the assertion you can build an insecure layer on top of a secure layer but you can't build a secure layer on top of an insecure layer.  And so in this case, gold might be the secure layer or Bitcoin but then this rehypothecated (Inaudible 00:11:56/Clack Mayer) is the insecure layer that's built on top of it, if I'm understanding you correctly?

CAITLIN:                   Yeah, that's right.  And pretty much all of Wall Street because it's based on debt-based assets is the insecure layer.  The only secure layer is your actual equity-based asset which is underlying that entire pyramid of insecure layer that's build on top of it.  It's inherently unstable.

TRACE:                      Now, and so when we look at the gold market where there is hundreds of paper ounces for every physical ounce, that's actually in the bulk.  And an interesting gold -- yeah, interesting worst story as a big investor in gold money before Bitcoin even existed and James Turk who came up with it.  When he went to start the business back in 2001 first of all none of the bullion banks would deal with him but he finally like got a bullion bank to deal with him and so they are going to make the contract and a big deal with old money instead of physical ounce has to equal a digital ounce in the database.  And so what they wanted to do is they wanted to have their own little cage down in the vault in London and they wanted to -- when they paid for the gold bar with the wire transfer they wanted to move the physical gold bar into their own little cage, right?

CAITLIN:                   Yeah.

TRACE:                      I mean, it seem somewhat odd.  And the bullion bank was like, no, we wouldn't do that.  And they are like why not we sent the wire and like we are on the gold, they're like well that's just not how it's done.  And so in order to start gold money which now bolts over $2 billion of physical gold.  They actually had to go and because of some of the other shareholders who are big shareholders in mining and refinery companies, they had to go and strike a deal with a gold refinery and buy the physical gold as it came out of the refinery.

CAITLIN:                   Wow!

TRACE:                      To put in their own cage because none of the bullion banks would actually let people take physical delivery of the bars.

CAITLIN:                   Wow, wow!  And think about the analogy of that to Bitcoin which we're going to get into in a little bit.

TRACE:                      Yeah.  Yeah.  Because I mean there is a lot of stuff that's similar here because with Bitcoin when we're actually looking at the technology we have UTXOs which were the transaction outputs and you used UTXOs as the inputs and then the outputs and so every transaction has a public key and input public key output and so you melt down the UTXO and you recast it into a new UTXO that's associated with the outputs in that transaction, which you don’t necessarily do with gold.

CAITLIN:                   Right.

TRACE:                      Like a gold money there was a scare in a gold market about tungsten.  And so what we did is we actually went and ultrasound tested every single gold bar because you have LBMA standards and then you have indemnification agreements within the chain of custody with LBMA.  And so we ultrasound tested every gold bar and we found eight anomalies and we actually had those bars melted down and recast.  And they were actually just anomalies in the reporting, they were of like by 1000 of an ounce or something.  So there wasn't materially wrong but if there were we would have exercised the indemnification causes in, you know, on those bars if they weren't actually real gold bars.  But in Bitcoin every day we have tens of thousands, hundreds of thousands of transactions that are melting down Bitcoin and recasting it every single day.  And to have a valid transaction you have to do that on the Bitcoin network.  And so we're going to get a little bit more about this into this ICE backed New York Stock Exchange announcement that recently came out, but before we get that I want to get to some of the definitions first.

CAITLIN:                   Yeah.

TRACE:                      So, I talk about the seven network effects, we've got speculation, everybody chasing the rabbit.  Merchant, consumers, that are using it in retail transactions because people are valuing it as speculators.  Miners securing it, developers building on the most secure block chain.  The sixth network effect which is really the top of this podcast is financialization and then world reserve settlement currency.  So financialization, if you look at any of the comments or any of the twitter conversations, keyboard don't seem to know their nose from their ear.  So perhaps, you can help us understand like what is financialization actually mean?

CAITLIN:                   Well, I think in the context of the sixth network effect that you talk about it, it's what I would the good type of financialization which is new investors are coming into the universe, especially institutional investors and they are creating real liquidity, legitimate liquidity from investing in the asset class, but there is a bad type of financialization which comes, I called it leverage-based financialization.  That's liquidity that arises from the creation of unbacked claims to the underlying asset, creating more paper claims to the asset than there are actual assets.  And that is liquidity, it certainly can boost the price of the asset in short term and the speculator certainly would like that.  But overtime, it's going to suppress the price of the asset because ultimately it does counteract the scarcity of the underlying.  So the fact that there are so many more paper claims to gold and silver than there is actual gold and silver, that same thing could happen to Bitcoin and I think that surprised a lot of people when I started talking about this a couple of days ago in the piece I wrote about in forbes.com and then yesterday came the ICE, New York Stock Exchange announcement and a lot of people, you know, that major reaction was oh! my gosh, this is really positive, it's the main streaming.  Of course, it is that, but I raised the question.  This is probably a double-edged sword because I think this is the beginning of the creation of unbacked claims to Bitcoin which so far have -- they are happening on the margin, but they haven't happened in big size.

TRACE:                      Oh! well, what about okay, I mean, $400 million isn't a very size?

CAITLIN:                   Yeah, but it's still -- that's 400 million is nothing when it comes to institutional standards.  And I do think that's one of the sources.  I actually did have some folks saying, wait a minute there is a Bitcoin lending market, wait a minute there are big trades happening, but it's generally speaking very small compared to what an institution like the New York Stock Exchange, sister company backed could bring to the Bitcoin market.  We're talking about substantially increasing the volume of transactions and they're building their own second layer and likely starting to create unbacked claims.  I had said in -- unbacked claims Bitcoin.  As I've written in that Forbes' piece which -- this was very lucky timing.  It came out two days before the announcement.  I was going to be on the lookout for big enterprise, you know, big company institutions who introduced Bitcoin settled contracts as one of the warning signs that this bad type of financialization is coming.

TRACE:                      Now, what do you mean by Bitcoin settled because like I interviewed Paul Chou of LedgerX, they have swap execution facility, they are doing Bitcoin settled swaps and then also putting call options.  So what exactly do you mean by like a Bitcoin settled versus say a cash settled CME option (Inaudible 00:19:35)?

CAITLIN:                   Yeah.  That's a great point.  The CME and CBOE this is another thing that I think of.  There's confusion out there based on the social media announce -- comments because a lot of people are like wait a minute CME and CBOE got into this awhile back, this is old news, no, there is a huge difference.  The ICE announcement of backed is Bitcoin settled contract where as the CME and CBOE are cash settled.  LedgerX, you pointed out to me.  LedgerX had already gotten Bitcoin settled derivatives and they got approval for it late last year.  So they technically have already been out there but in very size and it's interesting.  I have attended a number of meetings and breakfast of large institutional trading houses on Wall Street and they look at the big counterparties, they want big ballot sheets as their counterparties.  They don't look at small startups as counterparties sure on the march and they'll trade with them.  But the magnitude of the capital in the clearing house or the exchange matters to them greatly.  So sure, on the margin they are using LedgerX but to bring in an ICE affiliates is just a different zip code and that's the big, you know, large balance sheet established layers getting into this market that I was saying is a warning sign that we're going to start to see this unbacked claims creep into the market and indeed two days later it happened.

TRACE:                      But now -- but this unbacked claim, they are happening on an insecure layer that's not on the base layer of Bitcoin.  So if, you know, and it's misses rights there's no way to avoid the final crack up boom.  So if the HODLgang decides to take physical delivery of their Bitcoins to their own private keys what effect could that possibly have on this gigantic balance sheets that you're saying that these people only want to interact with?

CAITLIN:                   Well, it's interesting because I asked the question at one of the breakfasts that I was invited to and this was a group of credit traders.  And I asked them, what's the inherit limitation on Wall Street's ability to create paper Bitcoins that are not backed by real Bitcoins.  And it was an interesting theoretical discussion because a couple of them hadn't thought it through.  And again, a lot of Wall Street folks are just, head down in their own narrow areas of expertise and not necessarily asking a big question like that.  What's the inherent size of the Bitcoin derivatives market, the paper claims to Bitcoin that are unbacked by Bitcoin, how big can that get if the HODLers are not allowing their Bitcoins to be available for borrow.  So you talk about gold earlier.  That's an asset that the financial system controls because mostly gold is owned by central banks or the big gold vaults which are owned by big financial institutions.  So that is an asset that the financial industry can control, how much leverage is placed on it because they actually own the underlying.  In Bitcoin, that's not true.  And so if we have HODLers that are not making their Bitcoins available to the institutional market to be lent and to create claim upon claim upon claim upon claim on top of, how big can that derivatives market get.  And it was a question that stumped a lot of people.  And I thought a lot about it before writing that piece on forbes.com.  I really do think that that the HODLers are the reason to be optimistic that we'll not going to see in the Bitcoin market the same trend as what happened in say gold and silver.  We're not going to get that far out of whacked in terms of paper claims to Bitcoin relative to the underlying.

TRACE:                      So do you think this could lead to a cultural clash between the HODLers of Last Resort as I like to term them and Speculators, you know, people like Novogratz, for example, or other people who are just chasing the rabbit up and down?

CAITLIN:                   Yes.  And by the way I think that that fault line exists in the main stream financial markets too.  There's a term called real money investors.  Real money investors are pension funds, mutual funds, insurance companies, these are long-own lien investors for the most part, they don't do a lot of trading around their assets, they don’t swords, they don't try to naked sword, right, they have compliance departments that prevent them from doing that sort of thing.  They are not the ones that caused the Dole Food problem.  It's the speculator that caused the Dole Food problem where they were 49.2 million valid claims all backed up by brokerage statement to the 36.7 million shares of Dole Food outstanding, right?  So you actually had the financial system create one third more real claims to Dole Food shares and Dole Food shares exist.  The real money investors don't do that and that's what we wanted Bitcoin, that's a good type of financialization.  The pension funds, the mutual funds, the insurance companies.  Now here is the back-door way that the speculators can use the real money investors and that is the details of how the real money investors hold those assets in custody are really going to matter.  What do I mean by that?

TRACE:                      Yeah.  I mean, could you give some example because like with backed we've got this guarantee fund which like, I mean, like, there's no margin for error with Bitcoin.  If you get hacked like your cash balance is gone, like there is no reversing, there is no like how could a guarantee fund really cover a Mt. Gox or an OKX?

CAITLIN:                   Well, I think the devil on that one is going to be in the details, but I will note as a side note that the guarantee fund, the existence of a guarantee fund means that backed is de facto with bidding, that they are going to have unbacked claims to Bitcoin.  Because if it were a 100% backed why would you need a guarantee fund.  A bank that is literally just a money warehouse holding clients it bounces on behalf of clients and never lending them out will never go bankrupt, they will never a guarantee fund.

TRACE:                      Well, what about theft?

CAITLIN:                   Well, I don't know.  The devil is going to be on the details on whether the guarantee fund covers stuff.  Guarantee fund typically are 1% of the notional value, maybe 2%, the FDIC or the PBDC, these are tiny funds relative to the massive, gigantic amount of money that they guarantee.

TRACE:                      Yeah, it's like what?  $48 billion in FDIC versus like 10 trillion of client deposits or something like that?

CAITLIN:                   Yeah, I don't know the numbers but it's something on that order of magnitude.  So guarantee fund are not designed for force majeure type massive losses.  They're designed to cover small losses, like, the OKX situation.  And clearly the fact that any clearing house admits that it needs a guarantee fund, is a de facto admission that they are creating unbacked claims to the underlying asset because they would never need a guarantee fund if they weren't.  They would never have any leverage and therefore never go bust if they weren't.  But the point that I was making earlier about the custody arrangements for long only investors is a little bit different.  That is the SCC requires that every asset manager who manages a $150 million or more has to hold those assets in a segregated third-party custodian.  And that's a passage of history that Bitcoin folks will scratch their heads and say why.  Because you can't mess around with Bitcoin, it's totally transparent as to who owns it and with the exception of whether the private keys are stolen which is really more of a question of, for insurance.  You don’t really need a third-party custodian because you can't make off with the a paper stock certificates or paper bonds like you could have a 100 years ago when they created the need for the custody role, I think the custody role is not a 100 years old but it's quite old.  Anyway, long or short it is in existence and frankly this is the one thing I wish the SCC would do is acknowledged that real block chains are inherently custodians in and of themselves and you don't need a third party custodian.  That would be the most helpful regulatory change that the SCC could do to frankly solidify the U.S.'s lead in these assets.  But that's an aside.  That custodian is like a stage three or Northern Trust, these guys actually take the assets and hold them in custody.  And again, in history when securities were in paper form they had held them in a vault and they only deliver them when they verified that the customer had actually asked for them.  So that, the modern analogy is these custodians are going to hold the private keys on behalf of the large institutions who don't want to hold the private keys themselves.  But here is where the unbacked claims of Bitcoin can leak into the market.  If the custodian turns around and lends out those Bitcoins then that's when you can start to get unbacked claims and get the application hanged.  Yeah.

TRACE:                      Whether it's State Street or DTCC or I mean, we have seen all types of problems in this realm, haven't we?

CAITLIN:                   Yeah.  I'm optimistic and this is why I'm spending a lot of time educating institutional investors, speaking to pension fund groups and the like on, you don't want to actually lend out your Bitcoins.  You may be forced into using a third-party custodian and giving them the keys.  But don't let them turn around and lend it out because the moment you expose those keys you actually do take a lot of risk that those assets disappear.  This are digital barrier assets and it's not a traditional custodial relationship which is why it's unfortunate that the custody rule is forcing crypto assets into this old regulatory regime where you got to have a third party and you can't have responsibility for it on your own.  But that's the reality and so I'm encouraging just like Andreas Antonopoulos is encouraging all the individual holders of Bitcoin, I'm encouraging the institutional holders of Bitcoin, do not engage in lending of your coins with a financial institution that's then going to turn around and rehypothecate because what they're going to do is promise those Bitcoins to multiple parties, all of whom will claim on their financial institutions that they own the Bitcoins but there's really only one coin.

TRACE:                      Yeah, I mean, at Armory when we talk to institutions they were very interested in holding their own keys and, you know, -- but the software and the procedure is not really built around so doing that maybe that solution will get solved.  And you're also hitting on issues that are definitely problematic for the ETF and things of that nature, right?

CAITLIN:                   Sure.  Yeah.  And I do think again the institutions you were probably talking to in the early days probably warned the registered investment advisers managing a $150 million or more.  If you look at like how DRW set it up, they are all using an independent organization DRW set up Cumberland, for example.  Why did they have to set up an independent organization because they were already above a 150 million in their main hedge fund business so they had to set up aside card independent entity that holds their Bitcoin otherwise they would have had to have gone out and found a third party custodian and run into that smacked up into that problem that a lot of smart people are trying to solve which is how are we going to create a third party custodian without forcing people into major cyber security issues.

TRACE:                      Yeah.  So let's switch gears over to this ICE announcement.  To preface it, you know, the Bitcoin stock to flow is just a very different dynamic.  We have 12-and-a-half Bitcoins produced every 10 minutes, that's going to have in about year-and-a-half or so.  We have 17 million Bitcoins total.  So to really get new supply of Bitcoin because you can't get it from mines like you do with gold.

CAITLIN:                   Yeah.

TRACE:                      I mean, the stock of flow is so low.  Then the real flow of Bitcoin's going to be coming from the second, third network effects of the merchants and consumer, so perhaps you can help us understand how is this NYSE, New York Stock Exchange backed?  How was the Bitcoin going to flow through this engine?

CAITLIN:                   Well, it's very interesting because they're using physical settled futures contract so they're going to be getting the Bitcoin as collateral from their customers but there's also this parallel announcement of working with Starbucks on retail payment.

TRACE:                      And Microsoft.

CAITLIN:                   I found that -- well, it's right, but Microsoft is providing the technology, the cloud doing it on Azure which is great.  Microsoft is -- they've been a big supporter of this industry and that's welcomed.  And as Starbucks I looked at the retail payments thing and said yeah, Starbucks had -- Howard Schultz had said in an interview, about six plus months ago that they were looking at doing a coin and now we see what it is and that's great.  But what's fascinating to me is that ICE is an operator of exchanges, it's institutional financial market infrastructure and now it's got a retail payments business appended to it.  And you and I talked about this before the show, why?  Would it combine those two, wouldn't they've never done anything in retail payments before.  And I think you're hitting on it.  It has to do with being in the flow of the Bitcoins is my guess.  And my guess is that they are going to comingle, I don't know.  This is a question that I asked Matt (Inaudible 00:33:23) in a twitter exchange to ask them.  Are they going to comingle the Bitcoins coming in and out of the retail payments with Starbucks with the Bitcoins that are collateralized in the Bitcoin futures?  And if you look at the Fortune Magazine interview where they're going to a fair amount of detail.  They do talk about holding the Bitcoins in omnibus account.  What I can't tell from that is whether they're comingling the Bitcoins from both the retail and the payments piece.

TRACE:                      So if you were advising or interacting with institutional that wanted to use a service, how would you recommend that they approach that user agreement or those terms when it comes to like what public key the Bitcoins are actually like associated with or stored in?

CAITLIN:                   Well, it a same advice that I give which I learned from Andreas on holding your own private keys.  Sure.  If you want to use in exchange you're going to have to give up your private keys, you're going to send your coins to the exchange but the moment that you transact you want to take them back and possess your private keys again.  You don't to store your assets in that exchange because that's then an IOU, you don't own your Bitcoin unless you own your private keys.  But -- and furthermore, I would also, if you have to post-collateral which of course on a futures contract you're going to be posting collateral.  I would also look into the details on whether that clearing house where you're posting your Bitcoins as collateral is going to rehypothecate your coins.  I'm almost certain the answer is going to yes because that's the normal way that clearing houses make money.  They rehypothecate, collateral and they make money by transaction fees on transactions.

TRACE:                      I guess, a different way to ask a question would be instead of sending Bitcoins into one giant omnibus account that the exchange has like why doesn't the exchange just provide a public key for each individual participant?  And then that participant knows that their Bitcoins are sitting in a particular public key that the ICE are backed, isn't -- has access to but they are able to track and see whether those Bitcoins move or not.

CAITLIN:                   Yeah.  Well, that would be ideal.

TRACE:                      All right.  Well, I mean that -- but that would just be a trivial software implementation.

CAITLIN:                   It would be.

TRACE:                      So why wouldn't ICE are backed implement it that way?

CAITLIN:                   Because they can make more money by creating unbacked claims to Bitcoin.

TRACE:                      But who has to bear the risk when they do that?

CAITLIN:                   The Bitcoin owners, who participate in that structure.

TRACE:                      So is there really any reason why the ICE or this backed institutional customers why they wouldn't demand to have the Bitcoins being in a specific public key in order to make sure that their Bitcoins are safety segregated in this allocated, allocated type storage?

CAITLIN:                   Well, they absolutely should and unfortunately that's not how the clearing houses work.  When we use a clearing house or an exchange you're going into omnibus account, it's very unlikely that backed would agree to do that.  Well, but backed on this other point about institutional custodianship that's where the fiduciaries of the pension funds and the managers of the mutual funds absolutely must take control of that issue and not allow their assets to be rehypothecated or traded in a securities lending market.  There's too much risk, much more risk for Bitcoin lending than there is for securities lending where if something goes wrong, there's a fault tolerance in the system where the footings don't have to match every night.  And they can just create a paper, a new paper share of Dole Food in order to make a total snatch, right, you can't do that with Bitcoins so that the lending risk on this custody arrangement is absolutely critical.  The custody is different than exchange.  Custody is where you're storing, the exchange and the clearing house is where you're trading and my advice to everyone regardless of whether institution or individual is don't store your assets on an exchange.  I love Matt Levine, the Bloomberg reporter who writes a daily mail, I almost always read, he's great, he just makes a point all the time that this Bitcoin exchanges exist through one reason and that is to get hacked.  And this is funny how he writes about it, but it's true.  And so the devil's in the details.  If you are storing your assets on one of those insecure layers, you are number one, not owning your Bitcoin, number two, you're allowing the financial system to leverage your assets and create multiple layers of paper claims and number 3 you're insecure.  And so, you really want to make sure that your custodian either self-custody or if you are a big institution you can't because it's too big, you got to be sure you control that relationship.

TRACE:                      Well, and this -- doesn't this go back to just a type of plumbing when you are dealing with Omnibus accounts I mean it's a bank account, right, it’s not like you're going to create a bank account, a client trust account for each institution's money that comes in.  I mean, it just all gets wired into the Omnibus account.

CAITLIN:                   That's right.

TRACE:                      But in Bitcoin's case it's a trivial software implementation to get each institution their own Bitcoin address to send coins into.

CAITLIN:                   That's right.

TRACE:                      So in terms of the plumbing, like, it just doesn't -- I mean, I could see where for practicality you would have an Omnibus account in terms of the bank accounts because you don't want to create individual bank accounts for -- on the exchange side for each partner but in Bitcoins' case you're just creating all these addresses on a software wise and then you're able to derive it using hierarchical deterministic wallets.  So you are backing up the seed once but then you're able to create million different public keys out of that, and each public key can be unique for each participants.  So then those participants can verify that the Bitcoins are actually in those addresses and they can see whenever they move in or out.  And it's like wow, wow why the Bitcoins move out?  I mean, if there is no real reason for that to happen under the user agreement?

CAITLIN:                   Yeah, absolutely.  And I've personally experienced that.  One of my pension clients discovered unauthorized securities lending and the security side that they would not have been able to discover because the brokerage statements didn't show it.  It was only when they were trying to transfer the assets to the insurance company to close this pension deal where they got a call from the custodian saying, oops! we've got about 15 securities that we don't have and at that time I, you know, at first hung up the phone and shout, oh! my God, these deal's going to fall apart, but then I called him back and said no, this is wrong, you need to demand and talk to the compliance department, if they didn't have authorization to do this and they were doing it anyway that's a huge compliance issue and if you don’t get satisfactory answer from them tell them you are going to the SCC this afternoon.  And magically, all those securities came back and close (Inaudible 00:40:52) and nothing ever got publicly reported.  That kind of stuff happens all the time. And you're actually right.  Bitcoin has the ability to give owners of assets, pensions funds, fiduciaries that control over those assets.  The problem is that they lose that control if they go into this pool of arrangements and that's why it's so important for the real money investors who are good financializing Bitcoin to keep control of their private keys and verify that those keys, you know, that their Bitcoin are not being co-mingled or lent out unless they specifically authorized them.

TRACE:                      Yeah.  And another point that we didn't hit on is forks.  And some of this forks has a significant amount of value.  For example, right now --

CAITLIN:                   Sure.

TRACE:                      -- it's about 12-and-a-half percent of the total Bitcoin amount is available on forks.  And so if the institutions aren't having the Bitcoins properly segregated then how can they -- because the forks it will happen at different blogs and so how could this fiduciaries know what forks are entitled to.

CAITLIN:                   Oh! yeah.  They have to get their feet wax, I mean, it's just something that somebody in asset class.

TRACE:                      Are they going to leave over a 1,000 basis points just sitting on the side lines and not claiming it on behalf of their, you know, the people who really on those assets, I mean, they wouldn't really be being a prudent fiduciary if they didn't.

CAITLIN:                   Well, gosh, did coin base deliver, be cashed to its --

TRACE:                      Eventually.  And it's noted Bitcoin (Inaudible 00:42:27)

CAITLIN:                   But it took months.

TRACE:                      -- and everything, yeah.  But I mean that was kind of the first round but now everybody is getting a lot more, they've gone through the process now.  And so investment trust, you know, they did all the cash in Bitcoin gold but, yeah, so I mean if these Bitcoins are getting lent out you don’t get the fork.

CAITLIN:                   That's right.

TRACE:                      And so that could be a big problem because these forks could cause some type of solvency risk to whoever can't deliver the securities, right?  You're like wow, wow, wow you owe me not only Bitcoin but you also owe me the Bitcoin cash and Bitcoin gold etc.

CAITLIN:                   Yeah, yeah, yeah, absolutely.  That's a great point.  I haven't thought about that.  I thought you were going in a slightly different direction which is if Bitcoin does get overwhelmingly financialize and starts to look like gold.  I think what's Wall Street risk in this leverage financializing of Bitcoin is that frankly the community who really controls it, right, the UASF situation prove that the community, the full -- people who run full Bitcoin notes really do control it.  And they'll just fork it and go to something else.  It's a same reaction that what happened if they really were a -- they actually took over Bitcoin in a 51% attack.  The community will just pick up stakes and fork it and go to the honest chain.  And I think that there's -- Wall Street probably doesn't understand.  It's got a risk against the real people who can control Bitcoin which is full note users that it didn't have with gold and other commodities that it went to town creating paper claims that it's far exceeded the underlying.

TRACE:                      Well, this is kind of funny.  I was actually at one of the major Wall Street banks at their headquarter, I think, in January and about, you know, I was going to go and give a little impromptu Q&A in a middle of a trading day to the guys on the training for, there were supposed to be about three or four.  And the next thing I know there's like eight or nine people in there and they're all like managing directors and above.  So we're just kind of having a chat and one of the assertions I made was like, look, you guys can't make a torch cell Bitcoin like you've done with gold.

CAITLIN:                   Yeah.

TRACE:                      And one of them was like well, why not and I was like because big HODLers are going to fork it and then will bankrupt you.

CAITLER:                  Right.  That's exactly right.

TRACE:                      Because you're not going to have the fork because you've been rehypothecating and they could start selling it.  So we're going to squeeze you on the fork's side.  And, you know, they are going to like big eyeballs, you know, so.

CAITLIN:                   Yeah, they don't understand that risk.  You are absolutely right, Trace, I'm so glad we're talking about this because they don't understand they can't control Bitcoin.

TRACE:                      Yeah.  So, you know, and that you want to be a first-class Bitcoin citizen you got to run your own (Inaudible 00:45:17) note and you got to hold your own private keys.  So let's -- you know, as we kind to wind up the interview let's switch our gears to the large macro picture.  The geo-political, the geo-strategic picture.  And let's look at it from the U.S.'s point of view because the U.S. is the dominant yield, you know, power entity.  So we had the Bank of England fail and Isaac knew and created the gold standard.  The gold standard lay the foundation for just an unprecedented golden age and the founding fathers put it into the constitution, right?  You know, Article 1, Section 10 Clause 1 so we were supposed to have an equity-based monetary system, but that got eroded and then we have Executive Order 6102 with Franklin Roosevelt that made hoarding gold illegal.  And then the case got squarely framed but the Supreme Court refused to hear it because it's political question and City v. Dover of what is a dollar and whether it has to be gold or not.  So they punched it on that.  So you know, the system has to lurch from one crisis to another until eventually it will cumulate or culminate in hyperinflation or deflation or depression.  And then, out of this 2007/2008 mess, the software gets sent out called Bitcoin.

CAITLIN:                   Yeah.

TRACE:                      And it starts developing and it develops this market.  The next thing you know this thing is using more electricity than the entire country of Chile on an annual basis.  And then there's this gigantic fight about how to scale it and do we scale it a way that you have to hard fork and centralize it or do we scale it with additional layers, you know, Adam Back and Nick Szabo's vision with and then things like lightning network.  But in order to really do that new development you had to get segregated witness activated and that became kind of a real knockdown, drag out fight where the Chinese miners would not activate this stuff.  And then on August 1st, you know, so we're at the one-year anniversary of that, (Inaudible 00:47:22/Sedgley) got activated.  Within a month, Russia, China and Iran had launched their new gold trading platform.  Within a month of that, the CME futures got approved.  And then now, we've got LedgerX and Backed that are going to physically settled Bitcoin futures.  And so this is -- I mean, if you look at the light speed at which the -- the pieces are moving on the chessboard.  What effect would an equity base monetary system have over, you know, if we transition from the current debt-based monetary system into an equity-based one, and if the U.S. is leading the road to that, what effect could that have for the U.S. over the next couple centuries?

CAITLIN:                   Oh! my Gosh, it would be tremendously beneficial to the U.S.  We have an equity-based monetary system.  Really up until 1969 which is (Inaudible 00:48:16) and that's when we started cheating by -- we always has debt, but the debt was always backed by real savings and I give a speech on this and showed the numbers to the Mises Institute San Francisco circle and I believe it was April or May.  Maybe you can put that in a show notes because it actually very clearly shows that the amount of non-financial sector debt was equal to the amount of personal savings in the U.S. up until 1969.  And then we started cheating and that started to exceed the amount of personal savings, that's was Mises would call it circulation credit.  That's unbacked claims to the wealth of United States and we just have gone to town on that.  And so what we had was much, much more stability in a financial system and a greater period of wealth expansion than when we were on an equity-based financial system.  And I absolutely believe if we went back to that, we'd have a much fairer and more stable financial system that is really what I'm passionate about educating folks that we don't have a stable and fair financial system now and the answer to that is not to put pedal to the metal on debt and they make even more unfair and unstable the answer is to transition to an equity-based financial system.  I don't think that the politicians, people in control would voluntarily do that.  But I think it's coming.  I think your point about Bitcoin being the world's reserve currency eventually, I have said it may take 20 years but we're going to be using it in payment.  It's just too far -- too much efficient and safe as a financial system than this -- than the current system.  But I think the current system is probably going to keep going for a while and we're just going to continue to seeing worst incoming quality and bigger instability, bigger booms and bigger corrections in markets if you look back that's exactly the pattern that we've been in for the last 45 years or so.  And it's the pattern that's likely to continue until the world transitions to something better.  And the great news is I used to be very (Inaudible 00:50:30) about this when I figured all this out studying the alternative schools and economics after the financial crisis.  I got optimistic when I figured out Bitcoin because I understood this is the way for individuals to protect assets and opted out, and I'll close these remarks by saying the person who gave me the most sage financial advice in my life is my uneducated grandfather.  I think he finished 8th grade, he was a farmer and die before I was born but my father passed the advice down and my dad was born in December 1929 so right after the black Tuesday Stock Market crash in 1929.  And he used to scoff at people of all the paper assets, he never trusted the paper assets, he always understood that owning equity-based assets implicitly was the only way to protect your wealth and he gave me -- that was the most sage advice I've ever had.  Because I look at the incredible paper wealth that's been created and I understand that it's unstable -- inherently unstable behind it in a way that my grandfather inherently knew it was unstable and he lost money in a bank failure but he was able to keep his farm and a lot of the other families in the area we're not because they engaged in paper base speculation so it was sage advice.

TRACE:                      Yeah.  So I mean we look at the stone age didn't end because of a lack of stones and we've got Putin, you know, at 2016 he talked about whoever adopts block chain technology first is going to be a big leader.  From what I understand about 200 of the top people on the block chain industry have been basically had their Chinese passports taken away and they're being forced to help come up with a strategy for the Chinese government on how to apply this.  Yeah.  And so then it becomes a question for U.S. you know, and it's why, why should we fear to use it an equity-based monetary system.  The world's at a very unique place where it's rethinking what money is.  Is it gold, you know, in Chinese and the Russians are stock piling that like crazy but that's going to the past and even if we use gold as a secure layer we would have to build a second layer on top of it for the actual plumbing like we've talked about.

CAITLIN:                   Yeah.

TRACE:                      How would we build the secure layer on top of it?  And then is it going to be the dollar?  Well that's, you know, the dollar and euro and ruble and all these things, they have all their own problems or is it going to be something else like Bitcoin.  And Bitcoin, you know, it looks like it's getting the green light.  A lot of big major serious players are moving into this stuff and so you know why should we fear to use it, becomes a big question because it could actually lay the foundation for a new golden age for the U.S. and enabled the U.S. to maintain its financial and military and economic dominance far end of the future, would you agree with that?

CAITLIN:                   Yeah.  Well, I completely agree.  I don't think the politician will ever willingly go down that path because they recognized that they inherently dilute their own power.  There's a reason why the fights that we're seeing for political opposites are so nasty and so divided.  It’s because we put so much power into these positions and, you know, that's partly because they control their financial system and at the end of the day if the people actually control the financial system we end up with an equity-based financial system then power will devolve back to where it should be which is with the individuals.  And we will be able to keep the fruits of our own labor.  And we wouldn't have to worry about whether our financial institution is going to default upon us.  That is the idea.  I think we're going to get back there.  I just don't know what we're going to have to go through between now and then.  And Bitcoin is what makes me optimistic.  You've talked about greatest wealth transfer in history and I think you are right.  It's wealth transfer from folks who store wealth in this unstable paper-based assets where you know you don't know how many, how much over issuance that has happened until you have a Dole Food situation versus the stable equity-based assets like Bitcoin and it worries me that Wall Street is coming to financialize it but it's going to be a lot harder for Wall Street to financialize it the same way it had done with other equity-based assets.  And your listeners need to heed the advice which is hold on to your private keys because Wall Street cannot financialize something that it hasn't got no holder.

TRACE:                      Well, great advice.  Thanks so much for being with us, Caitlin.  If people want to be able to find you how did they do that?

CAITLIN:                   Ah! Caitlinlong.com and I've also just recently started to contribute to forbes.com that's where the serious that captured your attention on financializaton is published so you'd find it at forbes.com.

TRACE:                      Well, thanks so much for being with us.  It's been a long time we've been together in this space shoulders and shoulders and --

CAITLIN:                   Oh, yeah.

TRACE:                      -- I think we have a very bright future so keep up the good work.

CAITLN:                    Oh, you too, Trace.  Thanks so much.

Written by Trace Mayer on August 4, 2018.