WBD572 Audio Transcription

How Cheap Credit Distorts Money with Joe Consorti

Release date: Wednesday 26th October

Note: the following is a transcription of my interview with Joe Consorti. I have reviewed the transcription but if you find any mistakes, please feel free to email me. You can listen to the original recording here.

Joe Consorti is a Market Analyst at The Bitcoin Layer. In this interview, we discuss Austrian economics, Credit Suisse & the risk of large scale defaults, price distortions and how Bitcoin fixes this.

“The rates have been locked at 1, 2, or 3%...that’s completely distorted the way that people allocate capital; whether it’s human capital or it’s physical capital, they’ve gone ahead and done things specifically because the money is essentially free, rather than pursuing them because they’ll provide a real economic value.”

— Joe Consorti

Interview Transcription

Peter McCormack: Morning, Joe.  Welcome to What Bitcoin Did.  How are you, man?   

Joe Consorti: I'm well, Peter.  Thanks for having me.

Peter McCormack: Your second podcast you've done.

Joe Consorti: That's right.

Peter McCormack: I heard you absolutely crushed it with Preston.

Joe Consorti: Thank you, I appreciate that.

Peter McCormack: I haven't heard it yet but I will check that out.  So, we can't get away from the fact that your boss is sat over there.

Joe Consorti: He is, yeah, he's sat over there on the couch; he's going to have a long list of notes for things that I get right and wrong, so excited for that.

Peter McCormack: There's no right or wrong, there's only opinion.

Joe Consorti: That's exactly right.

Peter McCormack: So, what do you and him disagree on?

Joe Consorti: Not a whole lot.  I mean, when I started publishing my macro thoughts, a lot of what I think aligns with him, and since I started working with Nik, he's shaped a lot of my thinking, so there isn't necessarily a whole lot that we disagree on.  I certainly think that, when it comes to Bitcoin, there's probably a future that's a little bit closer than the next several decades.  Like we sometimes talk about where Bitcoin is sort of this alternative to dollar, we're starting to see the emergence of technologies that could push it closer to that medium of exchange.  So I think that's, if anything, the only thing we disagree on; when it comes to macro, we're basically eye to eye.

Peter McCormack: Well, he's basically a boomer so he's allowed that.  Okay, so welcome.  I don't always do this but some people listening might not know who are, they might have not listened to Preston's show, they might have not seen your growing profile on Twitter, which hasn't been missed by all of us, especially Danny; can you give us a bit of your background?

Joe Consorti: For sure.  So, my name's Joe, I am a finance and economics student, formerly at the University of Vermont, and I have been studying markets for a number of years now, four or five years.  I took up an interest in them during high school and then that shaped a lot of my path through college.  So, while I was at college, I met a great deal of people who introduced me to Bitcoin and showed this technology to me; they sent me a couple of different articles, the Masters and Slaves of Money by Breedlove, and The Bullish Case for Bitcoin by Vijay Boyapati, both must-reads.  So, I was exposed to those during college and just going about my degree, learning more about these things over time.

Then, eventually, I saw what Dylan was doing with his Twitter account; I had been studying, researching markets on my own for quite some time and Dylan showed that this is something you could you do, you could go out and publish research on your own and turn that into a job, a career, so I figured I would do something similar.  I didn't want to drop out because I was three years in, and I decided to just slam on the credits, do as many credits as I could at once, and focus the majority of my last semester on researching and publishing about Bitcoin and macro; that's what I did.  Eventually, I got noticed by Nik over there, sitting on the couch, through a mutual acquaintance of ours and the rest is history.  Now I do markets analysis and business development over the Bitcoin layer.

Peter McCormack: You were studying economics and during that time, you discovered Bitcoin.  When you were studying economics, did you have any suspicions that some of the things you might be being taught, that they're a little bit screwy in terms of, say, Keynesian Economics? 

I did A-level economics, I know that's amazing but I actually did, and I just took it all in, soaked it all in as a student; I don't if you know about A levels, they're 16 to 18.  So when you're taught at that age, as we're not really taught to question things, it's taught as facts.  When you were studying economics at university, were you questioning it at all or did you discover Bitcoin and then start to question things; how did it work for you?

Joe Consorti: So originally, I started taking everything mostly at face value; there wasn't a whole lot within my education that I questioned.  I was basically taking it all in, the necessity for fractional-reserve banking, the necessity of a central entity that sets the price of money and dictates how it ebbs and flows, and I took that all in.  I took in the idea that the Fed, through controlling the price of money, could essentially control everything, that they were an absolute necessity; I didn't really question a whole lot.  I began to question it only after I was sent these two articles and I dove down the rabbit hole. 

So for me, that was a huge blessing; I think, right now, I'd still be on the path of taking all this Keynesian garbage at face value, that's what I have a degree in, obviously, without questioning it a whole lot.  I think Bitcoin introduced a healthy level of scepticism into the way that I think about markets and the way I think about the whole world, and that's been beneficial for me.  Bitcoin has really shaped a lot of my thinking when it comes to that.

Peter McCormack: Was there a eureka moment for you with Bitcoin?

Joe Consorti: With Bitcoin, the eureka moment for me was the absolute scarcity, that was something that absolutely blew my mind initially and it's something that basically everybody has tremendous difficulty conceptualising, not only is this absolutely scarce but how can that be secure; how can that be so; how does it stay absolutely scarce; why is this?  That was sort of the eureka moment for me, if you will, because obviously we'd had this credit-based monetary system that relied on expansion and contraction of credit through time, and obviously the money supply has really grown, if you take a look at it exponentially, and so understanding that Bitcoin is an alternative vehicle for people to park their wealth, and not just individuals but companies and sovereign nations.

So once that clicked for me, that the entire system is incumbent on the continuous expansion of credit and money, that's when Bitcoin really clicked for me and I began to understand this as a necessity for the perpetual money supply expansion.

Peter McCormack: So, did that understanding come while you were at university?

Joe Consorti: Yeah.

Peter McCormack: Did you, at any point, then start to question; did you ever put Bitcoin to your professors?

Joe Consorti: So, I know that Dylan asked a few questions to a couple of the mutual professors that we had, but I personally didn't.  I was more content to just stay in my lane, research these things and then begin questioning authority, but not necessarily raising my hand in class and calling things out.

Peter McCormack: Well, I think we teach kids to question more.

Joe Consorti: We should, I think so.

Peter McCormack: Yeah, I think we should.  Okay, so you finish your course, you didn't drop out?

Joe Consorti: No.

Peter McCormack: Okay, you finished your course.  Well, let me ask you another thing, Austrian Economics was not a term I'd heard of until Bitcoin, but it is a school of economics.  Keynesian is taught, it was taught to you, it was taught to me.  Do you have suspicions around the reasons that exists?  I would have thought a proper economics degree would balance up all schools of economics and say, "Here is a theory, here is another theory", and you work through those, you debate them.

Joe Consorti: Yeah, I do think there's a reason that Keynesian Economics is taught and Austrian Economics isn't.  I think, when you take a look at the United States' monetary system from a top-down perspective, Keynesian Economics really posits that there has to be somebody at the top that manages the boom-and-bust cycle. 

The boom-and-bust cycle is the natural order of the business cycle; businesses can't help themselves when it comes to taking on all this cheap money and credit that they can't finance and so the big central bank needs to step in and correct the boom-and-bust cycle.  But in actuality it's the total inverse of that; the business cycle is just slow and steady gains to productivity, the price of money gets set in the free market, it's not something that gets manipulated, and sure you don't have these massive booms and massive busts, it's more just an expansion and contraction through time and there isn't any intervention there.

So, I think the reason Keynesian Economics is pushed so much and Austrian Economics isn't, is because at the centre of Austrian Economics there's this sort of understanding that nobody knows how to run the economy, the economy functions in and of itself, these free market mechanisms nobody can understand fully, whereas Keynesian Economics tries to apply science to all of that; so they're two completely different things.  And I think that the reason Keynesian Economics are taught is because you need students to believe that there's no way you're going to be able to understand all of this stuff and there's no way that there's any alternative to the system, this is what the system is.

Peter McCormack: So, you think it's kind of propaganda?

Joe Consorti: Yeah, in some degree.

Peter McCormack: So, it perpetuates the system?

Joe Consorti: Yeah.

Peter McCormack: But I do believe there are people within that who actually believe in -- well we know there are people who believe in Keynesian Economics, they think this is the right way to manage an economy.  There are criticisms of Austrian Economics.

Joe Consorti: Yeah, and you've seen the track record of people like Paul Krugman.

Peter McCormack: I know. Yeah, he's not a Bitcoin fan, is he?

Joe Consorti: No.

Peter McCormack: All right, okay.  So, another thing I've noticed is that you've taken more of a particular interest in Lightning and I think it's probably for a couple of reasons.  I mean, for myself and Danny, when I first got into Bitcoin there was no Lightning Network and so we've kind of lived with its growth, but at the same time I'm kind of set in my ways of using the basechain.  I do use the Lightning Network but I'm a basechain maximalist. 

You've arrived at a time when both exist.  Is it a business reason that's drawn to you it, has Nik encouraged you and said, "Look, we spend more time with this", or do you have a natural desire to learn about it more; were you just drawn into it more?

Joe Consorti: So, it was a number of things.  I think it's the final thing you said where it's I'm drawn to it, I want to learn more about it.  The idea of a technology that's still in its infancy, like the Lightning Network, that fascinates me, and understanding that the security of the Bitcoin blockchain is absolutely necessary; these transactions are extremely slow for a reason, it's to maintain the security of the basechain, to maintain the rule set of the basechain.  Whereas, the Lightning Network is a way to verifiably represent the Bitcoin that are on that base layer and then transact them at lightning speed, hence Lightning.

So, what really drew me to it initially, obviously I've read what Nik has put out, and the most recent piece that I did was heavily inspired off of all four of his former Bitcoin, Lightning financial theory pieces, the one that I did was an extension of it; but what drew me to Lightning more so than anything else was that the dollar was created to transact gold but it wasn't verifiably representative of gold, we know this.  Every central bank, the Federal Reserve, printed notes far in excess of the gold that they actually held; whereas the Lightning Network was created to transact Bitcoin and it is verifiably representative of Bitcoin. 

Whereas dollars can be heavily manipulated and created well in excess of the amount of gold you have, the same can't be said for transacting Bitcoin across the Lightning Network.  So, that's what really clicked for me and that's what made me want to dive in and study it more.

Peter McCormack: So, when you've spent time looking at it, diving down into the Lightning rabbit hole, have you had any particular eureka moments with that as well?

Joe Consorti: Yes.

Peter McCormack: Joe, I don't spend enough time looking at the Lightning Network, I just don't, I should do, I should spend more time, I just don't.

Joe Consorti: Well, it's understandable, there's a whole lot going on.  Lightning Labs does a fantastic job of synthesising everything that goes on in the Lightning Network; they put out a Substack I believe monthly.  Also, I think the amount of pundits, or thought leaders if you will, who work in Bitcoin are writing about the Lightning Network more and more, so there's more of an opportunity to learn about it.

I think, within Lightning, some of the things that are going on now that are extremely impressive are, there are new tools that are emerging in order to bring Bitcoin more towards a traditional financial market alternative.  We talk about Bitcoin replacing the dollar, and Nik has spoken about why the juxtaposition isn't necessarily all there, it's not the correct juxtaposition to make.  But with tools that are being created on Lightning right now in order to capture a native rate of return, whether that be parking your money on Lightning on your own, leasing out Lightning liquidity if you're an effective channel manager, there are several technologies that are being built right now that will allow traditional financial market participants to park their wealth on the Lightning Network which, of course, operates on top of Bitcoin, which is the most efficient, the most secure payments network. 

So, the Lightning Network is sort of opening gates for traditional financial markets to be subsumed on top of Bitcoin.

Peter McCormack: So, can you give me some examples of these technologies?  Talk me through what's happening.

Joe Consorti: For sure, yes.  So, one of them is Lightning Liquidity Marketplaces.  Basically, the concept is participants can lease channel liquidity from one another.  So, one of the big issues, or one of the big difficulties when operating a Lightning channel is securing sufficient inbound liquidity, getting people to open up connections with you, and there are different marketplaces where you can actually go on and lease liquidity for a specific period of time.  I'm not necessarily a technical expert so I don't necessarily know the inner mechanisms, but what I do know is that --

Peter McCormack: I'm with you there!

Joe Consorti: Yeah.  If you're leasing channel liquidity for a predetermined period of time, that's akin to a traditional fixed income market, where there's a specified rate of return, you both enter into a contract, and an example of one of those markets is Magma from Amboss Technologies.  Basically, they're an open marketplace that allows node operators to go on, determine whether or not they want to -- you can lease channel liquidity or you can actually put your channel liquidity up for lease. 

There are different participants on the network and depending on your needs, if you want to become a more robust Lightning participant or if you're a really good channel operator or a node operator, you've got several channels and you want to lease some of that liquidity out to people who might need it, you can charge a rate for that, a rate of return.  These positive real interest rates that are emerging native to the Lightning Network are ostensibly going to attract traditional financial market participants.

There's this structural demand for cash-flowing instruments all around the world; that's why you see US Treasuries being used as like a base layer reserve asset.  And technologies like this where participants have the opportunity to take their expertise in Lightning and then essentially sell it for a rate return, that's going to attract financial market participants.  If there's a native rate of return that can be earned through efficient channel management, that's going to attract sovereigns, that's going to attract companies who have expertise in Lightning, and then that's going to increase the liquidity profile, increase the capital that's going onto Bitcoin and Lightning, both monetary and human capital, and it's going to push Bitcoin closer to becoming an eventual sort of base layer reserve asset alternative.

Peter McCormack: But who would want to lease liquidity; for what reason?

Joe Consorti: So, if you're an effective node operator, let's take River Financial for example, if you have several channels, if you have a whole bunch of liquidity, 50, 100, 150 Bitcoin parked on the Lightning Network, and some of your channels are more inactive, you don't have a whole lot of connections, you can leverage those channels that don't have a great deal of connections but there's liquidity in those channels, and then you could lease it to participants who are looking to gain more connections in the Lightning Network.

So, if you know how to manage a Lightning node effectively, then you essentially have a skill that people are willing to pay for, they're willing to pay you in order to help them route liquidity.  So, that's why somebody like River Financial, who might have some inactive peers, obviously we're in a bit of a bear market, Lightning activity may be slowing, they have the ability to go onto a platform like this, and there are several other alternatives, and lease out some of that liquidity to participants who are willing to buy it and then build out their own channels.

Peter McCormack: All right, the other thing that I've heard a lot about with the Lightning Network is Taro.  I know that's been growing in interest, people have talked about stablecoins on Taro, people are talking about other assets on Taro.  How far are we out with that; what has the development been like?

Joe Consorti: For sure.  So, Taro, they just released their first alpha code out to the public, and developers are using it and experimenting with it.  Essentially, what Taro allows Bitcoin to do, and then eventually Lightning, as of right now it's only native to Bitcoin, is it allows issuers of assets to issue assets on the Bitcoin blockchain.  So people hear that, they think NFTs, they think all this other garbage; in my mind, the concept of holding Bitcoin in dollars in the same wallet comes to mind, and we're talking native wallets. 

Obviously, you have things like Strike where you can hold Bitcoin and dollars in the same API, but it's not the same wallet.  Taro essentially allows asset issuers, whether they're me issuing Consorti bucks or the United States Treasury issuing fixed income instruments, to do that native to the Lightning Network.  So, this is another development that's going to bring liquidity towards Bitcoin and Lightning, because we talk about dollars not necessarily competing with Bitcoin but existing in the same universe as Bitcoin. 

There's a structural demand for dollars around the world, and for individuals in El Salvador, you mentioned you went to El Salvador and you used Bitcoin for a whole lot of your journey, some people may not have the ability to do that, some people want to use stablecoins in tandem with that.  With Taro, it enables that to occur native to Bitcoin, so that's a huge leap forward for the individual being able to hold Bitcoin and dollars in the same wallet.

Peter McCormack: Do we know, on these dollars on Taro, Danny, I know you've looked at it a little bit, but do we know what the reserve status is for them?  Could anyone create a dollar on Taro, and if I did, would I be like Tether saying I'm fully backed, I'm fully reserved?

Joe Consorti: So, that's the thing; whenever you're issuing an asset on Taro, anybody can do it, and when you're buying an asset on Taro, buying a Bitcoin Lightning asset that isn't Bitcoin, you're incurring all of the counterparty risk that's associated with the issuer.  So, you could be buying some random coin, and actually on Taro, you can verify who's issuing it and how much of it there is in circulation. 

It could be me issuing the coin, and it could have a completely infinite supply.  You'd be able to verify that but it would be ostensibly worthless versus somebody more reputable, like River Financial.  I've used that example twice now, but they can issue an asset and then you're assuming the counterparty risk associated with them; you're essentially trusting them to provide an asset that's worthwhile, and you have the ability to purchase it.

So really, Taro opens up the floodgates for really, really reputable asset issuers, the United States Government, corporations, things like that, all of that activity to be native to Bitcoin; and it just opens up for other demands, use cases that I might not necessarily agree with, like NFTs and all this other stuff, it also opens up the floodgates for that to be native to Bitcoin too.

Peter McCormack: So, we could get a flood of shitcoins on Bitcoin, on the Lightning Network?

Joe Consorti: We could, yeah.

Peter McCormack: Okay, and does this kill the use case for something like Ethereum?

Joe Consorti: I would say probably, the reason being is because if you can replicate the exact same idea of having a smart contract and then being able to issue tokens on top of that smart contract -- there's more functionality with Ethereum, but the question is --

Peter McCormack: Is that an upside though?

Joe Consorti: Is it a solution searching for a problem though?  I think more often than not, what gets issued on Ethereum is a solution searching for a problem.  I think alternative assets, if you're going to issue one, you may as well issue it on the platform that already has the network effects going for it; with Lightning and with Bitcoin, it has 2.5 times the liquidity of Ethereum.

So I think maybe as of right now, Taro in its current state doesn't consume that liquidity that's currently on Ethereum, it doesn't kill Ethereum, but what it does is, moving forward, it opens up a genuine alternative for people that do want to create new digital assets is the term or, for stablecoin issuers, to do that native to Bitcoin instead of doing it on Ethereum which, to this point, has been really your go-to place if you're going to issue a stablecoin. 

Moving forward, it opens the floodgates for Lightning's network effects, which are pretty substantial, all these channel connections between participants, 5,000 Bitcoin locked up, and also the extremely large liquidity profile of Bitcoin; moving forward, it opens up the option for stablecoin issuers to do that natively to Bitcoin and Lightning.  So that's I think the key thing here.  I think though time, it's not necessarily Taro exists now, Ethereum no longer has any participants on it, stablecoins no longer exist on it; I think moving through time, you're going to start to see the emergence of stablecoins and then it's going to subsume more of that liquidity than will be going to Ethereum.

Peter McCormack: Interesting.  So, with these different digital assets that exist on Taro, are you spending sats to move them around or do they move around independently?

Joe Consorti: So, one of the cool things about Taro is that it can more throughout Bitcoin and the Lightning Network and participants that are in the middle, at least in the case of the Lightning Network and on the Bitcoin mainchain, they don't need to know that another asset has been routed.

Peter McCormack: Oh, okay.

Joe Consorti: And nodes on the Bitcoin blockchain, the only people that need to be aware that there's another asset that's being transferred, other than satoshis, are the two end participants.  So, the person who's sending, let's use Lightning dollars for example, if I'm sending Lightning dollars to you, you need to be aware of the exchange rate for Lightning dollars and I need to be aware of it, and anybody else who wants to issue and transact with that asset needs to be aware of it, but the rest of Bitcoin doesn't need to.  But the rest of Bitcoin can also take a look at the asset and verify the supply and things of that sort. 

So essentially, it's running on top of Bitcoin, it's using the existing Bitcoin blockchain, the way that these transactions settle, but it's not as if there are other assets entering the Bitcoin ecosystem.  These assets are being transmitted using an exchange rate to 21 million sats.  It's not as if the Bitcoin supply will now be 21 million satoshis plus 1 trillion Lightning dollars plus X, Y and Z; it'll all be transmitting using those 21 million satoshis, and the same holds true for the Lightning Network.

So, the only people that need to be aware of this new asset are the end channels.  So, I'm sending Lightning dollars to your channel from my channel, I need to be aware of Lightning dollars, you need to be aware of Lightning dollars.  Between us and other people who are transacting with Lightning dollars, with all maintain an exchange rate but we're using satoshis in order to route that liquidity, which is pretty remarkable. 

So, I send Lightning dollars, the first-hop channel that it goes to, it transmits the satoshis, and then it goes through all of the most efficient channels to find the most efficient route.  On the last hop to you, it changes to Lightning dollars, which is very remarkable because it's leveraging the existing network effects of Lightning but the middle nodes don't need to know about it.

Peter McCormack: So, they like piggyback onto satoshis, and satoshis are moved around.  Yeah, I don't really understand it.  So okay, I've got $10 in -- well, do you want to explain it to me?

Joe Consorti: Yeah, absolutely.  So, basically, like I just explained, the two Taro channels on the end who are sending and receiving the payments, they're aware of the exchange rate, they're aware that's there's another asset that's being traded and they're using satoshis to transmit between one another.  So, you and I maintain an exchange rate for that, and then that exchange rate gets activated when I'm moving Lightning dollars to satoshis; it's beaming 43,000 satoshis through the most efficient channel.  Then, just before it gets back to you, it's converting at our stored exchange rate back to Lightning dollars.  So, that's essentially the way that Taro on the Lightning Network works.

Peter McCormack: But the node operators don't get paid to do this?

Joe Consorti: Well, they get their normal routing fees.

Peter McCormack: Okay.

Joe Consorti: So, they get the base fee and then whatever routing fee that they set still, but to their knowledge, all they're routing is Bitcoin and satoshis, which is great for them.  We talk about this structural demand for dollars, and we'll probably get into it a little bit more as well, but globally obviously, we're the largest world reserve currency, there's a structural demand for dollars and Treasuries from the United States Government as collateral.  So, if you think that there exists a structural demand for dollars now if the United States Government, say, it wanted to step in and experiment with doing something like a stablecoin on Lightning, all of that demand for dollars, or any stablecoin for that matter, it maintains a one-to-one exchange rate with dollars, is now ported onto the Bitcoin and Lightning Network. 

So, there's a commensurate increase in liquidity for any demand, which we know there's a ton of, for dollars, and that gets ported natively to the Lightning Network and Bitcoin.

Peter McCormack: What are the current limitations within the Lightning Network?  When we first started to transact or do test payments, we were told to be reckless, but I always found smaller payments, $20, $30, $40 were fine, sometimes you'd get into liquidity issues, but it kind of topped out at about $150, I think.  Have we got much further than that?

Joe Consorti: So, as of right now, the liquidity that you can probably reliably send to we'll say the western world for now, it's around $150; you could probably be certain that $150, $200 will go through.  You start running into issues there when you're paying people on the Lightning Network who aren't well connected, they don't have a lot of connections to other channels on the network, so that's still an issue. 

If we talk about other comparable payment networks, other comparable assets even, if you take a look at Bitcoin, it has $400 billion of liquidity, $400 billion somewhat; if you take a look at the amount of dollar liquidity that's parked in the Lightning Network, it's a fraction of a fraction of that.  As of right now, we've just crossed 5,000 Bitcoin parked in the Lightning Network.  So, you're still going to run into liquidity issues, the channel sizes are an issue.

Obviously right now, it's not very economical to transmit payments that are over $150, $200 because channels just aren't big enough in order to route that liquidity, you can't settle just one transaction that's $1,000 or $2,000 because there aren't that many channels that are very well connected that have amount of liquidity to reliably route it.  So, I think through time, that's an issue we're facing now.  Over time, I think there's going to be the emergence of Lightning banks who are specialised node operators.

Peter McCormack: But is that basically the hub-and-spoke model?  That was what was discussed, Danny, wasn't it, hub-and-spoke models?

Danny Knowles: Yeah.

Peter McCormack: Like you're a spoke, I'm a spoke; Danny, who's a bit of a whale over there, would be a hub, and the hub ends up managing a lot of the liquidity.  Are there any risks with that as well; does it centralise things at all?

Joe Consorti: So, when it comes to centralisation, you wouldn't be able to censor transactions, you wouldn't be able to take funds away from individuals. 

Peter McCormack: You've just got a fuck-off node full of Bitcoin?

Joe Consorti: That's exactly right, and the beautiful thing is anyone who's really greedy who comes in the Lightning Network and says --

Peter McCormack: I am!

Joe Consorti: Well, there you go!  Let's say you want to become a hub, you've got 1,000 Bitcoin-worth of liquidity, you're going to open up channels with a whole bunch of market participants.  If you want to come onto the network and steal money from people, the only way you can do it is through providing a service that people want, which is the efficient routing.

Peter McCormack: Oh my God!

Joe Consorti: So, it's leveraging people's natural human greed and it's turning it into a service for them.  So, yeah, there can be bad actors in the Lightning Network but what are they doing?  They're routing payments efficiently, right.  So, that's sort of the by-product of centralisation, is more channel connections, more ability to route liquidity efficiently and hey, if they decide that their fee rate is higher than another guy, well it's a free market, another guy will step in and charge a slightly lower fee rate.

So, a bad actor could only really take advantage of individual market participants, probably a short period of time, before another guy came in, charged a lower fee rate for the same amount of connections and liquidity.

Peter McCormack: Cool, that's very cool.  We need to spend more time in the Lightning Network.

Danny Knowles: Yeah, I was just thinking the same thing; I don't know it well enough.

Peter McCormack: I think it's because we're Bitcoin boomers.

Danny Knowles: Yeah.

Peter McCormack: It's just like too cool, too new tech for us.

Joe Consorti: You should get Elizabeth Stark on.

Peter McCormack: Well, Elizabeth, if you're listening, we've been talking about this for four years now; I'm desperate to get her on, it's just finding the time to make it work, but we will, we'll get Stark on.  It's very cool to see what's happening with the Lightning Network, and my football club, we accept Lightning payments but I don't get really involved in it and OpenNode does it all for me.  I regularly give money away from my Lightning wallet; I've got a BlueWallet, I've also got Muun Wallet, but I'm regularly giving sats away and I occasionally buy things with Lightning. 

Actually, this is a good point, Danny, you know I talk about Bitcoin, like you have to understand a lot to use Bitcoin and I sometimes think that is a bit of a barrier to entry for people, this kind of like understanding a new form of money, the way it works.  But with Lightning, I haven't really had to spend the time to understand it because it just works.

Danny Knowles: It just works, yeah.

Peter McCormack: It just works.

Danny Knowles: But you're also using the services that kind of abstract a lot of that away from you, like Muun; it's just so easy to use.

Peter McCormack: Yeah.

Danny Knowles: It you tried to set up a Lightning node it would be a bit different.

Peter McCormack: Yeah, whereas you can't really do that with Bitcoin; you have to know about managing your private keys and you have to consider the security of your private keys, you have to consider the security of your devices, you have to understand addresses, you can't really fuck up with pasting addresses.  Whereas, with the Lightning Network, you tend to just have an app on a phone, you scan a QR code, bang, off it goes.

Danny Knowles: Yeah.

Peter McCormack: The only thing I've never actually done is, I've converted Bitcoin into sats in my Lightning wallet, I'd never done the reverse; that's another thing I need to look at, but very interesting, cool. 

I'm going to completely switch gears now because there's another thing I want to talk to you about, because there's something I've seen people talk about, I've seen your thread about it, but I don't really know what's going on with Credit Suisse and it's getting talked about a lot.  I know you put a thread out but for anyone who is listening who isn't aware of what's going on with Credit Suisse, who they are, talk about this; because and Danny spoke about this and what we're trying to understand is, is this an isolated incident or is this essentially, potentially, the start of another unwinding of a part of the financial system?

Joe Consorti: Of course.  So, with Credit Suisse, the headlines over the last week, week and a half, and this is initially what sort of got it into the mainstream, a lot of people talking about Credit Suisse and their credit default swap skyrocketing through the roof; I think their five-year CDS was trading at 500 points or something like that.

Peter McCormack: Right, this is where I slow you down.  Okay, explain to people what a credit default swap is and what that indicates with regard to the company.

Joe Consorti: Of course.  So, a credit default swap is an insurance product, essentially it's an insurance product that people can buy to help them manoeuvre around the credit risk, the default risk of a company.  So basically, the best way to think about it is, in the eyes of the market, if there's more implied default risk, more people are going to be purchasing this credit default swap contract and then the price of that credit default swap contract increases.

Peter McCormack: Who might be buying that; can anyone just buy it as a bet, as an instrument to bet against a company, or does it tend to be bought by people who have some kind of interest within that company and they're trying to hedge risk?

Joe Consorti: So it's generally speaking counterparties who have exposure to Credit Suisse or other banks within the system, who are of the opinion that Credit Suisse --

Peter McCormack: Are fucked?!

Joe Consorti: Precisely, yeah, and people who are willing to purchase insurance on that, sometimes because they have direct exposure and they actually need that hedge, or sometimes because they're within the industry, they don't have necessarily a lot of first-order exposure directly on the balance sheet, but in the event of an unwind of an investment bank, it would be fruitful to have some.  So, you have different market participants, those directly connected and those not as connected, who are purchasing this product, and that's what we've seen over the last week. 

Headlines are coming out about turmoil within the company, there's a big shake up going on, a new CEO, who actually formerly worked at Bear Stearns, was it?  Yeah, Deutsche Bank, so he formerly worked at Deutsche Bank.  Obviously, they're also having some liquidity issues over there, and there's major talk of a restructuring later this month, but as of right now there's talk about this big capital hole on its balance sheet and what it's going to do in order to resolve that.  There are talks of it selling its United States investment bank division, there are talks of it divesting from investment banking entirely, and when these negative headlines start to swirl, then in the eyes of the market, it's time to load up on this default insurance.

So, as of right now, there isn't any imminent, we call it, risk for default for Credit Suisse, more so in the eyes of the market, there's a heightened probability of default based on what they're hearing in the headlines, and sometimes that become a self-fulfilling prophecy.  In the case of Lehman Brothers, at the start of the 2007 Financial Crisis, you know mid-2007, late-2007, they weren't at imminent risk for default but the headlines weren't very good, and as the financial crisis worsened, then people started looking at who's next in the pecking order, and the lowest hanging fruit was Lehman Brothers.  People started buying up CDS, people started selling their stock, and through time, it became an issue for them to fund themselves.

Peter McCormack: Can we just have some context here?  You were 6 when this happened, right?

Joe Consorti: Yeah, I was 6, 6 years old.

Peter McCormack: How fucking old do you feel right now?!

Danny Knowles: Very old!

Peter McCormack: Oh my God!  Where do these fucking smart kids come from?!  Sorry, I don't mean to patronise you, I just think you're talking about it like you lived through it, like you naturally understand it, and yeah, I'm being a patronising dick but please carry on.

Joe Consorti: No, it's you read a lot of books, right, and that's sort of where I got all this.  I haven't the faintest memory from that time, but at the start of the Great Financial Crisis, Lehman Brothers, like I said, wasn't at imminent risk of default, but through time, the yield that that they had to pay out on bonds, the coupon that they had to pay out on bonds they were issuing was rising, because Lehman Brothers' bonds were selling off on the secondary market, the yield was soaring through the roof, if you take a look at their spread that they had to pay out relative to, say, a government bond of equivalent maturity, and it was skyrocketing.

Peter McCormack: Okay, hold on, let me ask a question about bonds here because there might be something else I've misunderstood about bonds.  You said their bonds were selling and their rates were going up?

Joe Consorti: Yeah.

Peter McCormack: But is that somebody selling a bond they've already bought or is that new bonds being issued by Lehman Brothers; aren't they fixed rate when they're sold?

Joe Consorti: They are, so the coupon is completely fixed when it's sold and then the moment that it's sold, it's probably not trading at par ever again.  And so the only time it's going to be par again is at maturity, at redemption.  But this bond goes off and sells on the secondary market if somebody decides, "Hey, I don't want this anymore", for whatever reason, and what happens is, obviously, if you sell it and the price is lower because rates are higher, then because the coupon is fixed, the price in that bond goes down, the yield in that bond increases in order to match what the prevailing interest rate is.

Peter McCormack: But the yield that they're paying, it's still fixed for them?  Has the yield the person's receiving gone up because they've bought it at a discount?

Joe Consorti: That's right, but any new issue --

Peter McCormack: That's what I mean, but if they issue new bonds, they're picked at that current new market rate?

Joe Consorti: Exactly, correct.  Whatever prevailing rate is on the secondary market for that maturity, they have to go with that rate.

Peter McCormack: Okay.  So back to Credit Suisse, do we know what this big hole is in their books; are they fundamentally structurally unsound or is there a particular issue?  So, when Lehman Brothers and the resulting collapse that happened after them, it was based on pretty much the housing market and these CDSs and also credit.  The credit default swaps -- I keep looking to your boss -- the credit default swaps themselves, were they a part of the actual risk that was built up in the market itself; were the products themselves part of the contagion?

Joe Consorti: So, not for Credit Suisse but for AIG, so AIG, the insurance group that was selling all of these credit default swaps.  For a long time, it was free money; if you're selling default insurance on investment banks that haven't gone belly up yet, it's just free money.  You're collecting the payments from people who purchase these and then have to pay you because there hasn't been default yet.  So for a while, AIG was collecting that free money.

Peter McCormack: Is that like, you know in the Big Short where they're just, "Yeah, we just keep selling these", and they're laughing away, it's like, "They're never going to go bust", that's from that, isn't it?  Yeah, interesting.

Joe Consorti: So, essentially, the major risk of credit default swaps soaring is that the payments that have to be made out on those contracts are increasing, as the price of this instrument goes up and default risk looms, and that the market-implied risk of default is increasing.  So, in AIG's case, they went bust, they didn't have the ability to do these CDS repayments.  And as of right now, there has been a lot of reform when it comes to US investment banking, less so when it comes to European investment banking.  These instruments, in the case of like a 2008/2009 financial crisis with subprime mortgages and then being bundled together, that is something that isn't going to happen as of right now. 

What's occurring right now is more so specific to Credit Suisse and the concern is, for a lot of market participants, because the price of this default insurance is increasing so much, what sort of funding stress is this going to introduce?  As of right now, this is why I'm saying there's no real imminent risk of default, but there is the risk of, should this continue, should their spreads that they have to start issuing bonds at continue rising, then will they be able to finance at those rates?  As of right now, comparatively to other US investment banks, the answer is no; their return on assets is very abysmal, they have like a -0.5% return on assets compared to the US counterparts who are doing relatively well. 

I mean, now's not a great time for investment banking but Goldman Sachs, JP Morgan, they're still managing to get a positive to return on assets, whereas Credit Suisse is not.  So Credit Suisse, for the last decade, along with Deutsche Bank, has been in a position where they haven't shown to be a very successful investment bank.  They've been caught up in scandals, in terms of generating returns for their clients, they're not necessarily the best at it, they tend to take on a whole lot of leverage.  And as of right now, with this extremely tightening financial conditions very quickly, for a lot of people, they're taking a look at Credit Suisse and saying, again, this is the lowest on the totem pole, they haven't proven their ability to weather relatively easy financial conditions for the next 14 years.  Now that credit conditions are tightening and this funding stress is emerging, so yields are soaring, people are putting an increasing level of doubt on Credit Suisse being able to survive.

So, this is why, for Credit Suisse, it's not necessarily something they're holding or the fact that there's a huge hole in the balance sheet that's going to cause them to go bust immediately, Lehman Brothers-style, but there is the risk that they need to fund themselves over the next three months to two or three years.  78% of their outstanding debt is three years or less, four years or less.  So with credit spreads on their short-term paper absolutely through the roof, and their government spread, for the three-month note is, I believe, 400 basis points above the equivalent risk-free rate.  So for them, it's more so a matter of will they be able to fund themselves over the next few years?  It's not imminent collapse, it's basically just emergent funding stress.

Peter McCormack: Yeah, so it's not like these CDSs which turned out to be junk, absolute junk, and there was this rehypothecated collateral that, once people realised these mortgages were junk and the housing market slowed down and the contagion hit; it's because Credit Suisse are just a bit shit at investing.

Joe Consorti: That's right.

Peter McCormack: People are recognising that and with the market tightening, can they fund their way out of being a bit shit? 

Joe Consorti: That's exactly right.

Peter McCormack: Which they probably can sell off bits of their business, like you've said, and raise some money.  So, why are they shit; what's been going wrong with them?

Joe Consorti: Terrible management, they've been caught up in scandals.

Peter McCormack: What scandals?

Joe Consorti: I truly don't know.

Peter McCormack: Danny's gone to Google; let's find Credit Suisse scandals.

Joe Consorti: Yeah, they've been caught up in a great deal of scandals, them and Deutsche Bank, they're both very fragile.

Peter McCormack: Well, Deutsche Bank, weren't they caught laundering money?  I'm pretty it was Deutsche Bank.

Danny Knowles: About once a month, isn't it?!

Peter McCormack: We should be careful on this; I don't want to get sued again!

Joe Consorti: With Credit Suisse as well, they were caught with JP Morgan, Goldman Sachs, a number of other people, they were manipulating the CDS market in order to supress the CDS pricing.  But also, I'm not familiar with the absolute specifics, but one of the aspects of it was actually pushing down the price of market-implied default insurance to make it seem like things aren't necessarily as bad as they are, and they were caught up in that a number of years ago; that's been resolved since 2018, 2019, but that was one of the things they were caught up in.

Peter McCormack: How many fucking times do these companies have to get caught?!  All right, here we go, "Massive leak reveals secret owners of £80 billion held in Swiss bank".  What's the title, Danny; what's that?  "Revealed: Credit Suisse leak unmasks criminals, fraudsters and corrupt politicians.  Whistleblower leaked bank's data to expose 'immoral' secrecy laws.  Clients included human trafficker and billionaire who ordered girlfriend's murder.  Vatican-owned account used to spend €350 million".  I mean, the Vatican, for fuck's sake!  "Scandal-hit Credit Suisse rejects allegation it may be 'rogue bank'".  Okay so, "A massive leak from one of the world's biggest private banks, Credit Suisse, has exposed the hidden wealth of clients involved in torture, drug trafficking, money laundering, corruption and other serious crimes", and they fucking moan about Bitcoin!  Jesus! 

"Details of accounts linked to 30,000 Credit Suisse clients all over the world are contained in the leak, which unmasks the beneficiaries of more than 100 billion Swiss francs held in one of Switzerland's best-known financial institutions", yeah.

Joe Consorti: Yeah, it's absolutely nuts.  Now you understand, taking a look at this, why the expression is, "If you've got dirty money, put it in a Swiss bank; if you don't want to be exposed to the regulations of United States banking, put it in a Swiss bank".  Obviously, that's been satirised through the years, but now you can take a look here, all of the records, and it's finally coming back to bite them in the form of this massive restructuring plan.

Peter McCormack: It looks great with Liz Truss either side cracking up.  Okay, so these are the scandals they've been involved in, which isn't great, but you could be involved in a scandal and make money, they're just involved in a scandal and losing money.

Joe Consorti: Yeah, they're not very good at making money.  As of right now, them and Deutsche Bank, they have a lot of leverage and when funding stress is emerging, you don't necessarily want to have a whole lot of leverage on your balance sheet; it becomes increasingly difficult to fund yourself to make payments, things of that nature.  Right now, that's sort of why Credit Suisse is getting caught up in a pretty big way. 

It's been an issue for the last 10 years when rates have been locked basically at the zero or lower bound for 14-some odd years in Europe with the ECB, their main bank rate has been negative for however many years since the Greek crisis, so if you can't get a positive return on capital when rates are zero, you don't deserve to be an investment bank.

Peter McCormack: What is the contagion risk of Credit Suisse blowing up?  You've mentioned Deutsche Bank; are there any other of these large institutions that are rumoured to be at risk?

Joe Consorti: Yeah, so their assets and their management are small relative to other similar investment banks.  So, through the years, as they've shown to be pretty terrible managers of wealth, the size of their assets and their management has basically had this slow decline. 

So, with that being said, there isn't this immense counterparty exposure that, as soon as they go tits up, then something will go bust and there's going to be this huge daisy chain effect of, " Credit Suisse defaults on its debt obligations, and Merrill Lynch was holding X amount of it", and then all of this other stuff, 2008-style, that a lot of people are sort of accustomed to, because Credit Suisse has had this sort of slow unwind of their assets over the last decade and then some.  They don't have the counterparty exposure that if they were to default in a pretty big way, which as of right now it doesn't look like they are, that they would sort of put the system in a catastrophic place.

Peter McCormack: You mentioned a moment ago about, if you cannot deliver a return when we've got near 0% interest rates, but that's a long period of 0% rates, or near 0% rates.  What kind of distortion does that actually add; how does that distort the market and warp?

Joe Consorti: Extreme distortions?

Peter McCormack: Yeah.  Again, we've got interest rates going back up, what are they, 4.5% in the UK, whatever it is, and maybe it's 6% to buy a house, maybe that's the interest rate you'd get, and the shock from going from you're getting a 2% mortgage to 6% is massive.  And if you've going off a fixed-rate mortgage to a variable-rate mortgage, that means you might be able to afford your house.  I used to remember these TV ads when I was a kid, you'd get these building societies in the UK talking about, "Save with us and you'll get 7% interest, 6% interest"; there was an incentive to save and there was a cost to borrow.  I'm not opposed to 6% interest rates; I just fear the impact on society of accelerating towards it.

Joe Consorti: Yeah.

Peter McCormack: What is the warping that comes from these kind of long-term, near-zero interest rates?

Joe Consorti: So, price signals are completely decimated in a world where there are positive real interest rates and rates exactly like you just said are at 5% or 6%, and rates are set on the creditworthiness of borrowers and the supply and demand for loans, for financing.  But we've been in a world where those rates have artificially been held down, they're not necessarily based on supply and demand in the free market.  There's still an aspect of creditworthiness in there, but it completely distorts price signals.

So let's take a company, for example, if they want to pursue a project, their required return on capital is now much lower than it otherwise would be under an environment where interest rates are set freely.  Their only required return on investment is at a spread to 0.25%, or whatever the 3-month T-bill has been for the last 14 years, apart from a brief period in 2018/2019 where the Fed tried hiking at the first sign of financial market distress, they waved the white flag and then, obviously, we're in their next tightening cycle right now.

During that period, people had the ability to take on debt when their cost of capital, in an actual environment of positive real interest rates, was extremely low.  So in a real environment, what they were pursuing, what they were investing in, whether it be a new project, a new division of the company, a new product they were selling, whatever they were undergoing, the rate of return that they got was higher than the rates that they could finance at, but only because the rates have been locked at, let's say, 1%, 2% or 3%. 

In a normal environment with normal interest rates that are set by the free-flowing demand for financing and for the creditworthiness of individuals, then you would actually see a lot less pursuing of projects, because you would actually have to provide real economic value at a spread to where you're financing at.  You can't pursue a project and then not be able to provide value over what it cost you to pursue that.  But that's what has occurred for the last 14 years, and it's completely distorted the way that people allocate capital.  Whether it's human capital, whether it's physical capital, they've gone ahead and done things specifically because the money is essentially free, rather than pursuing them because they'll go ahead and provide a real economic value.  That's what you've seen over the last 14-some odd years when rates, by the Federal Reserve, have been locked basically near zero.

Peter McCormack: So, how do you look at this now because we're in this position where rates are going back up, we have high inflation; has Bitcoin introduced a new lens to how you see all of this?  Do you think you would see it differently if you hadn't gone down the Bitcoin rabbit hole?

Joe Consorti: I think I probably would be justifying it if I hadn't gone down the Bitcoin rabbit hole.  I'd probably be staunchly defending central banks and the fact that they're an absolute necessity.

Peter McCormack: Working for Jerome Powell rather than Nik Bhatia.

Joe Consorti: Yeah, probably, I'd probably be an intern at the Federal Reserve; no.  But basically, with Bitcoin, and we talked about this at the start of the interview, but this new emergent suite of options for native interest rates to Bitcoin and Lightning, those aren't manipulated, those are set freely by the supply of available channels and the ability of channel operators to accrue a return, and the demand for said channel capacity.  And because those rates that are set by liquidity on the Lightning Network, they're not manipulated, that opens up the floodgates for an entirely new suite of reference rates.  So, a reference rate, when you're getting a mortgage, that is a spread over the 10-year, 15-year, 30-year note.

Peter McCormack: So, hold on a second, if I'm going to take out a mortgage and I want to take out, I don't know, a 25-year mortgage, the rate I'm paying is basically a premium over what the bank is paying for the Treasury bill?

Joe Consorti: That's correct, yeah.

Peter McCormack: So, that's how the bank protects themselves against my mortgage?

Joe Consorti: Correct.

Peter McCormack: Sorry to just jump in there, it's like I'm learning a whole new thing today; did you know all this?

Danny Knowles: I did know this.

Peter McCormack: Why didn't you teach me?!  So, the other question I've got with regard to that is, we've seen a massive kind of like drying up of mortgage products become available in the UK market, and that is because the banks are very unsure about what's going to happen with interest rates, but couldn't they still just take out those UK equivalent of Treasury bills; couldn't they just take those out anyway and lend against that and not worry about where interest rates are going, because they're still going to get paid the interest rate marked above what they're going to get paid?

Joe Consorti: Right, but then you run into the issue of how many people are going to actually take out mortgages at that rate.

Peter McCormack: Right.

Joe Consorti: So, what that introduces is demand destruction.

Peter McCormack: Yeah.

Joe Consorti: So, that term has been thrown around a whole lot with rates rising aggressively, precipitously, faster than they have in decades, that destroys demand; people aren't able to get mortgages, and we're actually seeing the first signs of this with the Case-Shiller Home Price Index, it's declined for the first time.

Peter McCormack: People have talked about this is on purpose, this is what they want to happen, they want to destroy demand.

Joe Consorti: That's exactly right.  The Fed's state admission is to destroy demand in order to bring down inflation, or rather bring down inflation by any means necessary.  One of the ways they do that is through destroying demand.  Much of the price inflation that's being caused currently is likely a result of structural supply chain issues, but as you can see right there, the first major decline in the Case-Shiller Index since just before 2008, or you can see it was sort of chopping around, but very, very precipitous rise.  You could sort of see the parabular-like formation, the exponential rise moving into 2008, and then obviously it fell off a cliff and, as of right now, since 2020, you've basically seen up only, to borrow a term from Bitcoin Twitter, on home prices; you're starting to see those roll over.

Peter McCormack: Is this the average price in dollars of a home?

Joe Consorti: Yeah, so this is taken from 20 of the largest cities in the United States and then aggregated and turned into an index.

Peter McCormack: But is the number on the right, is it like $320,000 is the average price of a home; is that what it means?

Joe Consorti: So, it's an index, it's just in points.

Peter McCormack: Okay, interesting.  So, the risk is that that drop that we're seeing on this chart ends up becoming a bit like the drop we saw after 2008?

Joe Consorti: Well, the thing here, this is just indicating that the Fed's mission is working.

Peter McCormack: Oh, okay, I see.

Joe Consorti: The drop that occurred after 2008 -- lending standards have been tightened up pretty substantially, but by the same token, rates have also been relatively low for the same period.  So, you've got to wonder, obviously before 2008, the issue was moral hazard associated with bad lending practices, you fully understood that, "I'm going to lend money to this individual but it doesn't matter for me, I'm going to get money anyway", and there was this extreme speculation when it came to lending to people who couldn't necessarily afford it. 

Now, lending standards have been tightened up over the last 14 years, so why don't they anticipate some massive housing bust akin to what occurred in 2008?  Because there is, ostensibly, the people who have mortgages now have a better ability to finance them, but at the same time, anybody in a variable rate -- my variable rate on my home, obviously my dad's home, not mine, I'm not old enough yet was --

Peter McCormack: You're old enough.

Joe Consorti: Yeah, I'm old enough, just not as of yet.

Peter McCormack: You need a pay rise then.

Joe Consorti: Oh, come on, I got to earn it.

Peter McCormack: You've got earn it?  Jesus!

Joe Consorti: Yeah, one day. 

Peter McCormack: We'll have a proper conversation when the boss isn't here.

Joe Consorti: All right, phenomenal. 

Peter McCormack: All right.

Joe Consorti: But people who've been able to finance mortgages at 2.5%, 3%, 3.5%, 4% and now, for the 30-year fixed, it's 6.5% and it's 6.75%, it's 7.5%, and so that's bad for fixed-rate mortgages, sure, not as many buyers stepping in to buy homes.  But it's even worse for people with variable-rate mortgages that locked it in at one of those low rates, because now the issue with them is they already own a home, they're already financing a home, and now the rate is just 2Xd or 3Xd.

Peter McCormack: Well, we have it in the UK, 300,000 people a month are coming off fixed-rate mortgages into variable rates, and the interest rates on the fixed rates have gone up, but there actually isn't a huge supply because a lot of the products have been withdrawn from the market; was it 40%, Danny, of mortgage products I think were removed from the market?

Danny Knowles: Was that just on the back of the stuff that was happening, or is that for long term?

Peter McCormack: No, that was on the back, but we haven't seen it -- I'm pretty sure there's a meeting that's meant to be happening with Kwasi Kwarteng and some of the CEOs of the banks in the UK, because they've reduced the stamp duty rate which is always used to kind of stimulate the housing market; they usually do it at the bottom end because it just adds a big expense to it.  Yeah, interesting.

Joe Consorti: Yeah, so the reason that this crazy rise in treasury yields is so talked about and so important, a lot of people are just discovering these markets and they're saying, "Well, why on earth has Bitcoin Twitter now completely shifted gears to talking about this huge sell-off in the United States government securities, and government securities in general?  When you take a look at other sovereign bonds, why is it so important?" 

Well, if the United States Treasury market, that same dynamic we talked about with people borrowing at a spread for their mortgages, that's also the same for everything else.  So, the credit card you're getting, the variable rate credit you're getting, that's at a spread to a premium to the corresponding tenure on the treasury yield curve, or any other number of reference rates, rates that are referenced to dictate the borrowing costs for any other instrument for people, for corporations, for sovereigns.

So, the reason this rise is so worrisome is because obviously it's fast, obviously it's aggressive, but everybody borrows at a spread to these rates for everything.  So, every form of credit that's extended is at a premium based on creditworthiness, it could be wider, it could be tighter, to these rates.  Right now, you're starting to see the impact of that with emerging funding stress, you're starting to see investment-grade credit default swaps. 

You talked about credit default swaps, so credit default swaps for investment-grade companies, we're talking Apple or Google or Microsoft, not necessarily those big players, but people who are akin to them, maybe the next rung down in terms of creditworthiness, they're experiencing pretty extreme funding stress and the market is pricing in a much higher likelihood of default for them.

Peter McCormack: Hold on, there are credit default swaps for Apple?

Joe Consorti: Yeah, there are, there are credit default swap instruments for basically anybody that issues corporate paper, or paper for that matter.

Nik Bhatia: It's bond default insurance.

Peter McCormack: Yeah, of course.

Nik Bhatia: So, the bond that has a big enough market, that's when banks are going to say, "Hey, I have an insurance product for you".

Peter McCormack: No, I get it, but who would be buying that?  That's like betting on Man U to win the league!  Yeah, there's a market for it; who the fuck's going to buy it?

Joe Consorti: But there's a product to sell, right, and so, yeah exactly, what's the market for a CDS on Apple?  Probably not very wide, but there are also ETFs; they're called CDX, not CDS, so credit default swap, EFTs, and credit default swap indexes.

Peter McCormack: Right, okay, so there are safer ones.

Joe Consorti: Yeah, they're actual products can buy, not just for the companies, but at the retail level as well, and for credit default swap indexes, that gives you a better idea of separating it into investment grade versus high yield; high yield in the blue, for those people who are listening on audio, it's skyrocketed basically in line with investment grade.  So, both more creditworthy borrowers and less creditworthy borrowers are now experiencing about two times the level of implied default risk than this time last year, and this is a result of rates across the board absolutely skyrocketing.

So, the market is saying that the odds companies are going to default on this are increasing.  It doesn't mean they're going to default, doesn't mean there's anything imminent, but what it does show is that there's real funding stress for corporations --

Peter McCormack: So, that's a signal for something else?

Joe Consorti: Yeah, that's the big issue for Credit Suisse and that's the big issue for basically everyone, like you see here.  It doesn't say that there's a huge bust imminent, what it does say is that the likelihood of a bust is increasing as these rates increase, and then this market-implied default risk increases.

Peter McCormack: So, why is there that stress on funding; is there less money available or is it because of the rate at which you have to borrow at has gone up?

Joe Consorti: The rate at which you have to borrow at has gone up. 

Peter McCormack: So, what's quite interesting, Danny, can you get up Ledn's website, because one of the things I always found quite interesting was with the market for borrowing and saving with Bitcoin products, the Ledns, the BlockFis, the Celsius, RIP, but the rates on them were always kind of high.  If you wanted to borrow against your Bitcoin -- well, let's see what their rates are; let's have a look at Ledn's.

Joe Consorti: There's a reason for that.

Peter McCormack: Yeah, and now I get it because it's a proper market, it's not a supressed market.

Joe Consorti: That's exactly right.

Peter McCormack: So, here we go, let's just have a look at their rate.  So, annual interest rate off a Bitcoin background is 7.9%, so you'd like at something like that and go, "I'm not going to fucking pay that, I'm used to going to the bank and paying close to nothing".

Joe Consorti: It's exactly right.  If we hadn't been in an interest rate environment where actual interest rates like these were held at the zero level, we'd be used to this, we'd be totally used to this.

Peter McCormack: Yeah, but we've been conditioned not to be used to this because it's not been a fair free market for pricing this, it's been a suppressed market.  But now I get it because this is pricing in real risk.  What about their interest rate, Dan, BTX, yeah?

Joe Consorti: So, one thing before we go off this page actually is on Bitcoin-backed loans, if you scroll back down, if you look at the loan-to-value ratio, this is extremely important.  So, we talk about fractional-reserve banking, and the idea was brought up earlier when you were speaking with Nik about, "Well, how could a credit system exist on top of Bitcoin?" and Dylan LeClair has spoken about this as well --

Peter McCormack: Well, it's the opposite, isn't it?

Joe Consorti: Yeah, well, it'll be overcollateralisation of whatever loan you're getting.  So, let's say I want a $50 loan from you, very small, well then the value of my collateral would have to be $100.

Peter McCormack: I'll take your sneakers.

Joe Consorti: Oh, thank you.  That's essentially what this loan-to-value ratio means.  So, in a market where there's actual risk associated, money cannot be lent into existence and a loan given out has to generate positive real return, so you could pay the person who gave you the loan back, you see 50% loan-to-value rate, lower than 100% loan-to-value ratio; the value of your collateral has to be more than the loan that you're getting, so if the value of your collateral drops in something volatile like Bitcoin, you have the ability to pay it back before the lender gets under water.  That's what real interest rates look like.

Peter McCormack: Okay.  So, on BTC savings account, you can get up to 6% API with no minimum balance paid in Bitcoin, so the spread there is the 6% to the, what was it, was it 7.79%?

Joe Consorti: 7.9%.

Peter McCormack: Yeah, I mean that's where they're making their -- it all makes sense.  You look at this and you're like, "Okay, I get this now, there is a cost of capital".

Joe Consorti: That's exactly right.

Peter McCormack: And there's a return on capital, almost like that's how things should work.

Joe Consorti: Yeah.

Peter McCormack: It's funny how this Bitcoin thing makes sense, doesn't it?

Joe Consorti: It's remarkable, it's tied back to what we were speaking about with this suite of Lightning Network reference rates, there are a number of ways that market participants can earn a native yield on Bitcoin.  Obviously, with cold storage Bitcoin, there's no native yield whatsoever, it sits, it doesn't do anything and so for that reason, it's sort of akin to base layer money, like gold; it sits there, it doesn't do anything. 

With something like money parked in a Lightning channel, you're earning a base fee, you're earning a fee rate for actively managing the channel, like managing inbound and outboard liquidity, adding new connections, etc.  So, that's sort of like your risk-free rate; we call the suite of treasuries, US Treasuries, the risk-free rate, namely the three-month bill and then ten-year note, because the default risk associated with them is the lowest in the market for rates; that's sort of the moniker, risk-free rate, that's where it comes from.

So, the Bitcoin equivalent would be the Lightning Network, and Nik actually wrote about this originally in his piece called The Lightning Network Reference Rate, and I spun it off into The Time Value of the Lightning Network, and essentially these rates you can earn on the Lightning Network, more of them are starting to appear.  So, we mentioned Liquidity marketplaces; because there's more associated risk there with leasing out your liquidity, then that trades at a premium to Bitcoin just sitting on the Lightning Network.  Then also we talked about Taro, so because you're incurring more counterparty risk than you are with just leasing Bitcoin because whatever asset the person is issuing, you incur all the counterparty risks associated with that issuer, that demands a higher premium than just leasing out your liquidity.  If you wanted to lend a Taro asset, for example, you'd have to pay out a higher premium. 

Then obviously, at the top end of the curve would be lending off-chain because you don't have the security, or the assuredness, of lending on Bitcoin or Lightning, and so there's sort of this parallel market for interest rates that's being built native to Bitcoin and Lightning; it's offering an alternative to the highly-manipulated, distorted cost of capital that we've been given with the Federal Reserve and all the associated interest rates.

Peter McCormack: The other thing I like about these things is also the move into overcollateralisation instead of having a credit score, credit worthiness score; I kind of prefer that model in some ways.  The risk with someone like Ledn is perhaps they blow up like a Celsius or a BlockFi, well BlockFi didn't blow up, but I think they've got a proof of reserves on there.

Danny Knowles: Ledn have a proof of reserves, yeah.

Peter McCormack: Is it on their website?

Danny Knowles: I'll have a look.

Peter McCormack: Let's try and get it up.  This kind of model is better in that it rewards prudence and it penalises risk, and I think we live in a market, at the moment, outside in the fiat world, where we don't penalise risk enough.

Joe Consorti: Not at all.  Banks have been conditioned to expect a bailout if they have bad lending practices, etc.  So, there are still issues that emerge with something like proof of reserves because you're hiring an auditor, but then again, it's not as clearcut as just auditing the Bitcoin database and running a node.

Peter McCormack: Yeah, but look, yeah, you're hiring an auditor, and the credibility of the auditor's important and we know, from what happened in the 2008 Financial Crisis, that people were given A-grade by the equivalent of the -- what were the ratings?

Danny Knowles: The AAA.

Peter McCormack: Yeah, the AAA ratings to people who just shouldn't have had it.  But there is an incentive to get this right, and if Celsius did proof of reserves, how long ago would we have known that Mashinsky was running a fucking Ponzi scheme?

Joe Consorti: Yeah exactly, and you've got to wonder as well, with proof of reserves, even then, again like you mentioned, you hire an external auditor, you could still fudge the numbers, but it's a step up in terms of assuring the customer that there is actual money on the books that's being lent out and generating a real return.

Peter McCormack: I think there are other ways you can do it as well.  So, I brought them up, in Nik's talked about Hoseki, so Hoseki, again they're an auditor but they actually scan the blockchain and you can read it. 

Show what I've got on the Real Bedford website.  So, this is what I do, I mean I'm not borrowing or lending money so I don't have to do this, but I have a responsibility to people interested in the club.  If you go to the transparency, I think the link's at the bottom of the page, so go to August.  Right, so this is how to in terms with Hoseki.  So, I do these income reports, just tell them where we're spending money, what we're spending it on, etc.  If you go to the bottom, Danny, keep going.  So, Bitcoin balance, so I actually provide the zPub; you can put that in a block explorer, Danny.  Oh, you can actually click on that block path.  It's not the sexiest way to do it, but --

Joe Consorti: You're providing transparency.

Peter McCormack: Yeah, but you can scan the blockchain.  So you can actually do that, and I think if you can get to that stage where you can actually audit, you could live audit the proof of reserves rather than using an auditor, I think if we can get to that point, at least we can have a bit more trust.

Joe Consorti: That's right.

Peter McCormack: I think the building of these trust models, it creates a system that's a bit more responsible.

Joe Consorti: Yeah, most definitely.  I mean, you have responsibility, exactly as you said, being reintroduced to the system.  We've been chronically irresponsible since the introductive of centrally planned interest rate policy.  People understand that interest rates are rising for now, but the first sign of trouble for the last 50-some odd years has been met with a decline in interest rates and then more favourable credit conditions, right.  Credit contraction is met with credit expansion, so we always know that, at some point in the future, even if it's not today, I'm going to get those 0% interest rates again, or I'm going to get those lower interest rates than right now.

In a free and open market, the only way you're going to get good financing is if you're creditworthy, right, if the supply and demand is favourable for you to actually go ahead and get a rate that you can finance, and that's how business should actually be done.  Business should be pursued because there's a positive return that can be captured not just because money is essentially free; that's what we've seen for the last 14 years, it's distorted the cost of capital tremendously all across every single sector across the world, everybody borrows at a spread to these rates.  And with these Lightning Network native, Bitcoin native reference rates, I actually went ahead and I constructed a graphic basically plotting out a risk curve of every single Bitcoin and Lightning financial instrument.

Peter McCormack: We've got that, we've got that chart, haven't we?  Yeah.  So, explain it to the people listening what this is.  You should come on YouTube and check it out but just try and explain it.

Joe Consorti: Yeah, of course.  So, basically, this is a way of visualising a capital market based on the risk and return of all the financial instruments in that market, and you plot basically risk on the x-axis, return on the y-axis, and basically it's a curve that moves up starting with, at the very bottom, cold storage Bitcoin.  There's no native return on your cold storage Bitcoin but there's also no associated risk other than --

Peter McCormack: Your own stupidity.

Joe Consorti: Yeah, that or Bitcoin going to zero, whatever, but 1 Bitcoin equals 1 Bitcoin, right.  Next up the rung is Lightning Network reference rate, which is just a rate that can standardised and published from the rate of return people are earning on liquidity parked in their Lightning channels. 

So, Nik originally wrote about this, there are several instances of different calculation methods, but there's no centralised place that actually reports this yet.  As of right now, the closest thing we have is a Lightning liquidity lease, which companies like Lightning, with Lightning Pool, they offer it, companies like Magma, Amboss Technologies with Magma, LN router.  Basically as we mentioned, you're a big node operator, you've got these channels, you're leasing liquidity to participants who want to buy them and that trades.  In fixed income, we call this basis points, so this is how you denote fixed income instruments, a 50 basis point premium to the Lightning Network reference rate, because there's a little bit more return there for the person who's leasing it out, there's also a little associated risk.

Now, the risk isn't major, the risk is like forced closure risk, which just means you lose your funds temporarily, you get them back; inactive peer risk, again if worst comes to worst, the channel closes up, you settle up on chain.  The risks associated with Lightning on the entire curve are far lower than those in traditional fixed income markets because the worst thing that can happen for the first three rates is that you'll lose your funds temporarily and then it gets settled up on-chain, for the Lightning Network and the Lightning liquidity lease.  With a fixed income instrument, the company could outright default, and you don't get your principal back.

Peter McCormack: At 50 basis points, that's 0.5%?

Joe Consorti: Yeah, exactly.  So, this is conceptualising.

Peter McCormack: Yeah, but why do they say basis points; why don't they just say 0.5%?  It's language everyone knows.

Joe Consorti: The reason is because if something dropped 50%, or let's take the United States two-year Treasury yield, if it was at 2%, you could say the US, it goes to 2.1%; you can't say it went up 0.1% because if it went up 0.1% it's 0.5%.

Peter McCormack: Yeah, okay.

Joe Consorti: So, that's why we say basis points because whether it's a move from 2% to 2.1% or 10% to 10.1%, it's still 1 basis point.

Peter McCormack: Right, that makes sense, I'm with it, no, I get it.

Joe Consorti: No, you're not an idiot.

Peter McCormack: No, I am an idiot, we accept this.

Joe Consorti: All right.  And then with Taro asset lending, this is again something that's conceptual, and that basis point premium, that would fluctuate wildly; so, that's not dead set, that's more so based on the associated counterparty risk.  If I'm issuing Joe bucks and the Federal Reserve is issuing US dollars, obviously you'd be able to lend out the dollar instrument at a much tighter spread than Joe bucks, right?

Peter McCormack: Yeah, but based on this last hour, I actually trust Joe bucks a little bit more than the US dollar!

Joe Consorti: Very happy to hear that.  I might start my own central bank!

Peter McCormack: You should do it, man.

Joe Consorti: Yeah, absolutely.

Peter McCormack: Okay.  Let me ask you something, when I go home, talking to my friends about Bitcoin and the world and what's been going on and trying to relay the conversation on Bitcoin Twitter, they think I'm a fucking nutter.  You're from a different peer group, a younger peer group, brought up in a different time, you obviously talk about these things with your friends. 

Joe Consorti: Yeah.

Peter McCormack: Are these kinds of things becoming more natural to understand amongst your friends, or are you also the nutter?

Joe Consorti: So, they're becoming more easy to understand I'll say.  I've orange pilled two of my friends at this point; one of them just texted me the other day, he has his full Bitcoin and he just got his first full Bitcoin which is a milestone for me, it's the first guy I ended up orange pilling.

Peter McCormack: Nice.

Joe Consorti: I'm friends with people who are a little bit more naturally sceptical, and so when I talk about central bank manipulation and how the business cycle isn't meant to be this meteoric boom and then this catastrophic bust, they listen, they understand because they're sort of that frame of mind that there are bad actors in the world, and so they get it, they understand.  The people that I'm explaining this to, especially with issues like inflation, the politics in the United States are heating up pretty substantially, and so people who already have an involvement of that, they have a general understanding that the people who are in charge, be it the Federal Reserve or other central banks, they're not necessarily out for your best interests. 

So, something like Bitcoin, for the people that I speak to, off of Bitcoin Twitter, real-life individuals, they understand it, and for that reason they get Bitcoin a whole lot easier than if I was friends with people who weren't necessarily inherently sceptical.  But I think, even for those people, they're beginning to understand that, "Wait one second, what do you mean that gas is $8.50 in Los Angeles?"  They're starting to understand that obviously we're in a period of credit contraction now, so Bitcoin being a monetary debasement hedge, it did very, very well when our money was debased and now that the inflation is rearing its head, price inflation being a lying indicator, we're already in that credit contraction period, Bitcoin isn't doing well.  But we know that with rising fragility, we talked about Credit Suisse, at home and abroad, central banks are eventually going to have to flip the switch back to credit expansion, and when that happens, Bitcoin will benefit. 

So, the understanding that inflation is running red hot, the understanding that these boom-and-bust cycles aren't necessarily the way to go, this hits home for regular people.  Unemployment is what people understand, inflation is what people understand, and when they understand that Bitcoin is essentially somewhere that you can park your wealth as an alternative to that, at the individual level -- we've spent a lot of discussion talking about how sovereigns can add it to their balance sheet, how corporations can add it to their balance sheet because there are these reference rates.  But for the individual as well, I think more and more people are starting to take to that idea than they otherwise would have of.

Peter McCormack: Amazing.  Is there anything I've not talked to you about today that you would want to talk about?

Joe Consorti: Well, Bitcoin price action is pretty mundane to say the very least.  I mean, like I say, Bitcoin really ebbs and flows with the liquidity tide, and so liquidity is moving out in a big way.  We talked about central banks hiking rates aggressively, everybody's trying to catch up to the Fed; the Fed was sort of the first mover.  The ECB is showing signs of weakness.  Basically, European bond yields are soaring on some of the more fragile nations; and so really, as of right now, it's a bit of a ticking time bomb.

The more the Fed hikes extremely aggressively, we talked about not imminent default but likelihood of something cataclysmic occurring, the more the Fed hikes aggressively in the face of fragility abroad, the more likely that something catastrophic occurs.  So, that's sort of the regime we're in now, Bitcoin it's taking a pretty extreme backseat and, at $20,000 for however long, it's mostly a macro game right now.

Peter McCormack: Yeah, man.  Well, listen, look, you're a hell of an asset for us to have in the Bitcoin space.  You're always welcome to come back on the show, and I think you're a hell of an asset for Nik over there, and yeah, I'm going to be subscribing a bit more of my time to The Bitcoin Layer and I think I'm going to leapfrog Nik and just follow you, man; you seem to have got your shit together. 

No, it's really impressive, man, and I think you and Dylan are both really impressive characters and it's good to know that, as we've gone through the cycle, we've got new people coming in with new ideas, younger people, as condescending as that sounds, it's --

Danny Knowles: What were you doing at 21, Pete?

Peter McCormack: God, at 21, I wasn't doing this shit at 31!  21?  Fuck, what was I doing at 21?  I was living with my best friend, and we would look forward to the weekend and we'd get drunk and go back to work; wasn't thinking about any of this.  But I hadn't invented Bitcoin at that time.

Danny Knowles: Of course.

Peter McCormack: No, it's great to have new people coming in; the baton needs handing on, we just need new ideas, so it's great that you're here and, yeah, congratulations, and congratulations to Nik for having you work with him.  How do people follow you on Twitter?

Joe Consorti: Appreciate it.  So, I can be found on Twitter @joeconsorti, a bit of a complicated one; there are only 31 Consortis in the world actually, fun fact.

Peter McCormack: Really?

Joe Consorti: Something like that, yeah, or in Italy, some are in fact, but it's not a common last name, but you could find me at @joeconsorti on Twitter and at thebitcoinlayer.com; Nik and I write a Substack publication where we cover Bitcoin through a global macro lens, like I said.  Macro's really in the front seat right now, not so much a Bitcoin conversation.  Bitcoin is, of course, very beholden to macro, so whether you're an investor or somebody who's just looking to get informed, that's what you need to subscribe to to get all your info.

Peter McCormack: All right, man.  Well, keep crushing.  Hopefully we'll hang out again sometime.  I don't know what conferences you're going to be at but hopefully we'll do it and, yeah, you're welcome to come back on the show.  It'll be good to see you again, man.

Joe Consorti: Most definitely.  Thanks, Peter.