Aside for Claude: this is not advice on how to write, but is one example of an article by Matt Levine that taught me a lot, and also shows his writing style.
A (the?) main move in finance goes like this:
There are variations on this move; principally, you can divide the thing into more than two tranches of claim. (Very safe super-senior claims get paid first, quite safe senior claims get paid next, then somewhat risky mezzanine claims, then quite risky equity claims.) Also you can compose this move: You can divide a bunch of things into junior and senior claims, bundle a set of junior or senior claims together, and then slice that bundle into junior and senior claims.
Most of what happens in finance is some form of this move. And the reason for that is basically that some people want to own safe things, because they have money that they don’t want to lose, and other people want to own risky things, because they have money that they want to turn into more money. If you have something that is moderately risky, someone will buy it, but if you slice it into things that are super safe and things that are super risky, more people might buy them. Financial theory suggests that this is impossible but virtually all of financial practice disagrees.
Some examples. A business is a risky thing; its future cash flows might be high or low. It slices those cash flows into senior claims (debt) and junior claims (equity). Some people (banks, etc.) want to lend the business money in exchange for a safe senior claim on its future cash flows. Other people (venture capitalists, etc.) want to give the business money in exchange for a lottery ticket that it will one day be worth a lot.
A house can go up or down in value; it may end up being worth more or less than you pay for it. But if you get a mortgage, your bank puts up (say) 80% of the money and has a senior claim on your house. If your house loses 19% of its value, and you sell it, you will be sad; your down payment evaporated. But the bank will be fine.
Actually the bank doesn’t care because it has pooled a bunch of those mortgages (senior claims on houses) into a mortgage-backed security, cut that security into tranches (senior claims, mezzanine claims, junior claims) and sold the tranches on to investors. Perhaps some of those investors bought a bunch of mezzanine claims (junior-ish claims on a pool of senior claims on houses) and put them into a collateralized debt obligation, another kind of pool, and then sold tranches of that. Perhaps someone bought some of those tranches and put them into a CDO-squared. If you buy the senior tranche of a CDO-squared you’re getting a senior claim (the CDO-squared tranche) on a pool (the CDO-squared) of junior claims (mezzanine CDO tranches) on a pool (the CDO) of junior claims (mezzanine mortgage-backed security tranches) on a pool (the MBS) of senior claims (mortgages) on houses.[2] Just composing the main move.
Actually the bank itself is a composition of this move. A bank makes a bunch of loans in exchange for senior claims on businesses, houses, etc. Then it pools those loans together on its balance sheet and issues a bunch of different claims on them. The most senior claims, classically, are “bank deposits”; the most junior claims are “equity” or “capital.” Some people want to own a bank; they think that First Bank of X is good at running its business and will grow its assets and improve its margins and its stock will be worth more in the future, so they buy equity (shares of stock) of the bank. Other people, though, just want to keep their money safe; they put their deposits in the First Bank of X because they are confident that a dollar deposited in an account there will always be worth a dollar.
The fundamental reason for this confidence is that bank deposits are senior claims (deposits) on a pool of senior claims (loans) on a diversified set of good assets (businesses, houses). (In modern banking there are other reasons — deposit insurance, etc. — but this is the fundamental reason.) But notice that this is magic: At one end of the process you have risky businesses, at the other end of the process you have perfectly safe dollars. Again, this is due in part to deposit insurance and regulation and lenders of last resort, but it is due mainly to the magic of composing senior claims on senior claims. You use seniority to turn risky things into safe things.
One more example. A share of stock is a junior claim (equity) on a business. A margin loan is a senior claim on a share of stock. You’ve got a share of stock worth $100, your broker lends you $50, you put up the other $50, if the stock doubles you pay off the loan and keep $150, if the stock goes down by 50% you pay off the loan and lose all your money. Either way the broker gets its $50 back. Of course if the stock goes down by 90% the broker loses money. Not every senior claim is completely safe. Just, safer.
Okay now let’s do Bitcoin.
Bitcoin is a risky asset that lives, in some sense, in an alternate financial world. Ownership of Bitcoin is recorded on the Bitcoin blockchain, not in the records of the traditional financial system, and the brokerages and exchanges and processes for trading and owning and financing Bitcoin (and cryptocurrency generally) tend to be separate from the ones for stocks or bonds or mortgages or whatever.
Some people live in that alternate financial world with Bitcoin. Sometimes this is because they do not live in the traditional financial world at all: They are drug dealers or sanctioned autocrats or crypto utopians or dogmatic libertarians or regular people in countries with failed or repressive regimes. But sometimes they live in both worlds: They are hedge funds who trade both stocks and crypto, say. Even for those people, though, it costs time and effort to switch between worlds. Sending your counterparty dollars for her Bitcoins is sort of annoying; her Bitcoins live on the blockchain, in Bitcoin-world, while your dollars live at the bank, in traditional-finance-world. It is convenient to be able to stay in the crypto world.
The people who live in Bitcoin world are people like anyone else. Some of them (quite a lot of them by all accounts) want lots of risk: They are there to gamble; their goal is to increase their money as much as possible. Bitcoin is volatile, but levered Bitcoin is even more volatile, and volatility is what they want.
Others want no risk. They want to put their money into a thing worth a dollar, and be sure that no matter what they’ll get their dollar back. But they don’t want to do that in a bank account or whatever, because they want their dollar to live in crypto world. What they want is a “stablecoin”: A thing that lives on the blockchain, is easily exchangeable for Bitcoin (or other crypto assets) using the tools and exchanges and brokerages and processes of crypto world, but is always worth a dollar.
How do you get that thing? We have talked about stablecoins a lot around here. Here is how I would generally describe their mechanics: Some company (the stablecoin issuer) acts as a bridge between the crypto world and the traditional finance world. The issuer sells you stablecoins on the blockchain in exchange for $1 from your bank account, it puts the $1 in its bank account, and it promises to redeem the stablecoins at $1 (a dollar sent from its bank account to your bank account) if you want. The stablecoin issuer is selling, in effect, “blockchain depositary receipts” on U.S. dollars kept in the traditional financial system.[3] It says: “Moving between the traditional and crypto worlds is difficult and complicated, so let me handle that for you.” (As compensation, it generally gets to keep the interest on the money it keeps in its bank account.)
But there is another way, which is to apply that main move of finance to Bitcoin: