Stablecoins

Protection from Volatility or Fractional Reserve?

The Stablecoin, a relatively new concept, turned the heads of numerous financial institutions, who have now launched exploratory missions into the previously isolated domain of cryptocurrency. This comes as no surprise, as its most common form closely resembles a traditional financial instrument.

Right away, several questions arise:

• What sets a stablecoin apart from the concept of digital fiat as a whole?
• Are stablecoins part of a larger play towards a cashless society and brave new world?
• Is this a ‘resignation’ or compromise of institutions when faced with the reality of disruptive tech?
• Or is it all merely an experiment?

Old Habits Die Hard

Decentralised cryptocurrencies have always been a relatively libertarian tool for individual empowerment and financial freedom. Centralised coins, on the other hand, rely on a backing reserve, licensing and legal compliance, auditing, and a gamut of onerous requirements from regulators.

Fiat-backed stablecoins are therefore rarely actual cryptocurrencies, which causes them to inherit their main characteristics and shortcomings from the centralised banking system. Ultimately, they function in the same manner as fiat, backed by what amounts to an IOU.

The recently announced JPM coin actually suggests that it may be the first stage towards building an inter-bank layer such as SWIFT, as it is restricted to institutional customers only, or even a new form of clearing and settlement.

As a natural consequence, this means that volume would likely number in the billions as well.

Similarly, Facebook recently signalled its intent to tackle the remittance market through the development of a stablecoin for transfers via WhatsApp. This, I suspect, will be in direct competition with Telegram who is also building an in-app payment functionality powered by their crypto token called GRAM.

Ultimately, we may be seeing the first stages of a heated competitive atmosphere. Here, it is also critical to note that any private currency can go public at a moments notice if necessary.

Uncertainties Concerning Tether

Tether (USDT), a ‘stablecoin’ released before the 2017 bull run, is a highly controversial token more or less pegged to the U.S. dollar.

Debates in the community remain on whether Tether has legitimately full reserves, reserves derived from unknown sources, or is running on a system of fractional reserve altogether. Even though the situation remains unclear, Tether has seen billions of dollars of volume thus far.

Still, I am not sure whether this amount of uncertainty coupled with massive volume can be good for crypto. No one wants ‘tethered’ to become the new “goxed”, which refers to losing assets in the collapse of the Mt. Gox exchange.

There is a theory that stablecoins such as Tether have been used both to stabilise and manipulate Bitcoin’s price, especially during the 2017 Bitcoin bull run. Data suggests a ‘conscious strategy to provide price support’ and this is very plausible given the lack of every-day use cases for Bitcoin. It is a good unit of account and store of value, and has a built-in method of exchange, but it is still not widely used as a currency enough to cause the sudden bull run it did in 2017.

If not stopped now while it’s still in its infancy at around a 10 billion USDT market cap, Tether could issue over 100 billion USDT in 5 years, controlling the entire ecosystem through corrupt exchanges and key insiders who prevented Bitcoin from scaling. Oddly, people won’t care about Bitcoin’s true values as long as the “Federal Reserve of Crypto” keeps printing Tethers, creating multiple bull cycles and mass liquidation events, keeping everyone content.

Tokenised Fiat Deposits: A Solution

One solution is tokenised fiat deposits, which represent real-world fiat currencies stored in segregated accounts and issued as digital tokens on a blockchain. This ensures transparency, regulatory compliance, and 100% backing of the tokens with actual fiat, avoiding the pitfalls of fractional reserves and unverified claims. One day, Plutus may be the first to implement this if no one else does it first.

Governments are Already Speculating

In a somewhat risky move to decouple from the petrodollar last year, Venezuela has created the Petro (Petromoneda), a cryptocurrency supposedly backed by the oil reserves of the country’s government. While possibly misguided, this experiment will undoubtedly not be the only foray of governments into the jungle of disruptive technology.

Institutions are now likely monitoring the Petro for lessons on how to avoid its downtrend, in order to proceed with their own plans. Bitcoin’s recent legitimate asset classification by legacy bankers should mark a huge step towards governments expressing interest in holding their own Bitcoin reserves if they haven’t already begun doing so.

How Stable is a Stablecoin?

What is important to remember, is that any asset may appear stable until it suddenly isn’t. Nassim Nicholas Taleb statistician and author of the “Black Swan”, has summed this up with a brilliant story about the Thanksgiving turkey:

“Consider a turkey that is fed every day. Every single feeding will firm up the bird’s belief that it is the general rule of life to be fed every day by friendly members of the human race looking out for its best interests.

On the afternoon of the Wednesday before Thanksgiving, something unexpected will happen to the turkey. It will incur a revision of belief.”

Will Bitcoin Become a Stablecoin?

Many consider BTC to be an anti-fragile risk hedge due to its decoupling from other international and national markets.

One could argue that it is only in comparison to fiat currency such as USD or EUR, and at the present moment, that the Bitcoin price appears volatile. In the context of hyper-inflated currencies and dysfunctional governments, BTC has held its value surprisingly well for an asset that does not restrict access to anyone in the world.

(At the very heart of Bitcoin is the idea that online banking should be equally available to any individual with an internet connection in all 195+ countries of the world. Even in the case of a worldwide EMP strike, there is a blockchain network running in the stratosphere to keep the tokenised economy alive.)

An often cited statistic notes that if merely 5% of total gold valuation moved to Bitcoin, then the market cap would already reach trillions of dollars. As a result, BTC would be worth more than $22,000 each.

Until volume increases and price supports solidify, there remains no hope for stability in cryptocurrency markets. Despite the current volume being higher than in Jan 2018 ($10 billion per day), they are simply not liquid enough or completely decentralised yet. We have to consider that it might take a financial collapse to herald the rapid arrival of an entirely new (digital) currency system.

We are still some time away from Satoshi’s original vision of digital cash, which allows everyone to mine cryptocurrency from their devices at home.

But before we get there:

For mass market adoption, we need the centralised and bank coins to drastically raise awareness, which they will do in the very near future.

A crossroad is coming.

The Next Steps

One plausible course of events that awaits us in the next few years:

• First, stablecoins reach peak visibility and usage. For example, if the U.S. Federal Reserve were to create a FedCoin, adoption could theoretically outpace BTC.
• Gradually the general public becomes knowledgeable about the advantages of decentralised systems.
• The UI and UX of decentralised technology improves tremendously through research, trial and error.
• Finally, a slow exodus pushes centralised stablecoin volume into decentralised currencies such as Bitcoin.

In the end, the problem of creating a stable and reliable store of value remains tough. In defiance of the ‘fiat paradigm’, many other projects are now attempting to approach this issue in a decentralised manner. However, for them to gain any traction whatsoever, they will first have to place the user experience of their customers ahead of anything else.