Bagehot's Reserve

Lombard Street 1873

The year is 2021, yet it is very reminiscent of 1873, back when Walter Bagehot wrote in his book, Lombard Street, that London's financial system was the most extraordinary combination of economic power and delicacy that the world had ever seen. Ten years prior to writing his book, Overend, Gurney, and Co, a firm known as the banker's bank lost its entire capital within a matter of six years, showing how fragile a system that relies on “long-established credit” can be. Within twenty years, the four great London Joint Stock Banks' liabilities had grown by a multiple of six while the Bank of England's private deposits had only increased by a factor of two. He foresaw a reckoning where panic in the market could create a situation where a run on the Bank of England would cause insolvency, despite being the “Lender of Last Resort.” Bagehot put forth mechanisms and a system that creates a strong foundation to base the financial markets. His solution's core pillar included a “Reserve Bank” that would lend based on strict collateral requirements, a fundamental piece to the Onomy Reserve (ORES).
Today, we see the unfolding of a similar scenario that Bagehot chronicled in his book within the currency markets. Starting with the secure yet slow Bitcoin, virtual currencies have evolved to the point where fiat currencies are now being represented as hard and soft pegged stablecoins. In addition, Central Banks around the world look to further digitize their currencies using similar technologies. The unpegged virtual currency markets are volatile, with people looking for riskless virtual assets as safe havens to trade out of riskier assets. Collateralized stablecoins also allow the leveraging of underlying collateral.
This was much the same, albeit with gold and silver, before the banking system, paper money, and securities were introduced in the western world. At that time, most people did not trust others with their silver or gold, and stored it within their homes. A professional that had saved their bullion and coins had no way of securely deploying it into the economy. When notes began to be issued, offering an outlet for this capital, the East Indies Company, South Sea Company, as well as companies for all sorts of various endeavors, sprang up only to provide returns based on speculation versus realized production.

Lombard Street 2021

Virtual currency markets have gone through similar cycles as those highlighted by Bagehot in 1873, modernizing his outlook over currency mechanics. The excess wealth created during the bull run of 2016-17 in the virtual currency markets had nowhere to go. This capital, combined with the advent of the Ethereum ERC20 token, allowed many companies to issue blockchain tokens and sell them to investors. The triviality of creating a blockchain token married to the excess capital led to an influx of newly-formed companies, both legitimate and illegitimate. This also led to the proliferation of “stablecoins”, which are parity-stabilized virtual currency representations of fiat currencies, primarily USD variants, initially used only by traders seeking less volatile refuges.
Stablecoins help manage market volatility by incentivizing protocol participants to stabilize the virtual currency with its represented fiat. With the volatility risk of unpegged virtual currencies is mitigated, stablecoins are now poised to become normalized within society as a form of payment and store of value. Thus, we are at the cusp of a financial revolution, the likes of which are more revolutionary than what Bagehot experienced and wrote about on Lombard Street. These stable coins will usher in the full-scale integration of the virtual world with the real world. The dawn of the virtual generation is here!
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Lombard Street 1873
Lombard Street 2021