Perpetual growth is bare essential for any pegged, collateralized or algorithmically stabilized cryptocurrency scheme to work, and no market can support bulls forever. Bears will eventually kill it. Such schemes of selling speculative crypto assets to acquire money only work as long as the humans are playing along.
A lot has been already written about stablecoins, and dozens of them are already out there either already launched, or in the process of launching, or on their way winding up. They have been applauded as “Holy Grail” of crypto. A review of each one of those is meaningless if this new hype around stablecoins does not hold water. Let’s see if it does.
Any stable money should maintain its value over a long period of time in terms of both convertibility and parity, which means it should be easy to liquidate at par value at any reasonable time in future. In technical terms it should be asymptotically stable.
In case of a currency collateralized or pegged to another asset, convertibility and parity are both very difficult, if not impossible, to achieve over time.
Let’s look at the four possible “Convertibility vs Parity” real world scenarios and investigate which one fits the so-called stablecoins.
Scenario-I: The Green Slice Of The Stablecoin Pie (+Convertibility +Parity)
100% cash collateralization is expensive and insolvency risk always looms large. It is difficult to sustain in the long terms unless the entity pegging or collateralizing its currency is a country backed by a strong economy, in which case pegging itself becomes redundant anyway. Why would a country with strong economy and strong currency peg its currency to another? Well there can be exceptions to that rule. China has a very strong economy but it still pegs its currency to USD. It does so not for stability per se, but to artificially keep its currency underpriced so that its exports become competitively priced in the global markets.
If convertibility and parity had 100% economic synergy fractional banking would not have been invented. The crypto economics, which largely thrives on speculators, cannot sustainably enable simultaneous convertibility and parity by pegging or collateralizing, or even algorithmically, unless a regulatory authority with legislative power is doing it. Period.
Scenario-II:The First Yellow Slice Of The Stablecoin Pie (+Convertibility -Parity)
Convertibility can likely be achieved at the expense of parity by diktats of dictatorial regimes like Venezuela, but certainly not by crypto maniacs who have no choice but to play it all in the free market economy. Even democratic Europe tried it once with ERM (European Exchange Rate Mechanism), but that infamous Black Wednesday in UK killed it in a single stroke. History of money tells us that it is not possible to hold the peg any longer than the currency issuer can afford it. So as the arrow in the Stablecoin Pie indicates the currency will eventually become a red slice lost cause.
Scenario-III: Second Yellow Slice Of The Stablecoin Pie (-Convertibility +Parity)
The leading coin in this category is Tether, which claims its tokens are backed 1:1 by USD in a bank account at unknown location, but lack of audit, and recent problems with banking spread uncertainty amongst the investors. There is no contractual mechanism to ensure the parity of these tokens with USD outside their parent exchange’s ecosystem. Time will tell if this is another pegging curse that’s headed to the red slice of the Stablecoin Pie.
Scenario-IV: The Red Slice Of The Stablecoin Pie (-Convertibility -Parity)
This is the final resting place for most pegged or collateralized stablecoins out there. Once their bull run is behind them, neither they will have convertibility beyond their underwriting/parent exchange’s shelter (of course until it lasts), nor sustainable parity with pegged currency. USDT is already suspected to head in that direction. Same will be the fate of so called algorithmically stabilized stablecoins, because selling unsupported speculative assets to acquire money is not the same as buying tangible sustainable assets to create money.
Lo and behold! Just as I was about to conclude this post, the most hyped stablecoin of 2018, backed by the Silicon Valley stalwarts, is reported to be shutting down and returning the $133 Million it raised back to the investors.
Conclusion: Whether collateralized, pegged or algorithmically stabilized, each and every stablecoin out there needs a speculation-independent self-sustaining ecosystem for long-term stability, which they all lack.
If appropriating money by selling speculative virtual assets is not the same as buying tangible sustainable assets, then how do we create asymptotically stable money?
That’s a conversation for another blog.
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