Liquidity: Liquidity is the invisible hand of market sentiment and asset cycles. There is no simple metric – subtle details matter. Low inflation gave central banks the license to be creative with policy, adding a dizzying number of tools to their toolkits. And now that liquidity conditions are contracting, the details of those tools have become very important. There was so much excess liquidity in the pandemic policy response that market rates were pressured to trade below the Fed’s floor. To ensure that didn’t happen, the reverse repo tool (RRP) was quietly expanded for the private sector. It is new for this cycle. And it’s visible, even if largely ignored. RRPs stood at $2.5 trillion at the June 2022 snap of the Fed’s balance sheet; in the 2018 period of QT, it was basically zero. Why does it matter? Well, when investors want to build liquidity buffers, they also want to shun risk of all sorts, even in money markets. The reverse repo facility is the lowest-risk way for investors to park cash, and financial plumbers have been warning about it for a while now. When RRPs are going up, and risk assets are going down, it is a bright red flag. The market is accelerating QT on behalf of the Fed, with excess reserves being drained. It is a dynamic that can bring QT to an abrupt halt. Digital asset markets provide a clear leading indicator of the speed at which liquidity tightening can matter. Digital is playing the role of EM in this asset downturn. Maturity transformation in the digital ecosystem has led to two risks. Liquidity risk – liabilities that are more liquid than assets mean financial intermediaries must gate investors to survive. Delinquency risk – add leverage to maturity transformation, and you get a jump to default. This rhymes with EM crises in past periods of rapid Fed tightening because it is precisely the same phenomenon. More than eleven intermediaries in digital assets have gated investors thus far. In response, new tools are being developed to ensure it does not happen again. Today, Nexo provided an attestation report on reserves and threatened legal action against those promoting inaccurate information. Kraken added a tool to the digital toolkit, expanding its proof-of-reserves audit to verify asset holdings on-chain. It all happens faster in digital. Risk assets, digital including, will take relief in the easing of inflationary pressures. The invisible hand of liquidity tightening must stay on the radar. It’s not over.