XCH as a store-of-value and collateral asset
For a Chinese version of this article see here.
Cryptocurrencies are store-of-value and collateral assets. Arguably, store-of-value is the prevailing use case for cryptocurrencies, given that Bitcoin, which effectively functions as digital gold, has a market capitalization greater than all other cryptocurrencies combined.
Amongst the myriad of cryptocurrencies in existence, XCH, the native token of the Chia blockchain, stands out. This article explores why XCH excels as a store-of-value and collateral asset, and compares its characteristics to Bitcoin and Ether.
Store-of-value
XCH is uniquely suited as a store-of-value asset due to its high degree of decentralization, fixed supply schedule, and powerful custody primitives.
Decentralization
For the native token of a blockchain to be a digital bearer asset that can accrue value, the underlying network of nodes needs to be decentralized. The greater the degree of decentralization, both in terms of full node count as well as Nakamoto coefficient,¹ the more confident users can be that the blockchain cannot be taken down by an attacker or the underlying ledger be tampered with, and that it remains permissionless and censorship-resistant.
Since Chia is stateless and scales via layer 2 solutions rather than having high TPS on layer 1, running a full node is low spec, both in terms of hardware and bandwidth requirements. A Raspberry Pi and domestic broadband connection is all that is needed to run a full node. This is reflected in Chia having around 100,000 (!) full nodes, more than twice as many as Bitcoin and about 15 times as many as Ethereum.
Thanks to Chia’s unique proof-of-space-and-time (PoST) incentive mechanism, which relies on computer storage space rather than the more familiar proof-of-work (PoW) employed by Bitcoin or proof-of-stake (PoS) used by Ethereum, anyone with spare hard drive capacity can become a farmer (miner). As a result, Chia’s Nakamoto coefficient, which stands at 10, is significantly greater than that of Bitcoin (2) or Ethereum (2).
Fixed supply schedule
While decentralization ensures that a cryptocurrency is a good store-of-value from a technological point of view, there is also an economic component. Only if the supply schedule of the cryptocurrency is fixed, can it reliably functions as a store-of-value. After all, if the supply schedule can be changed, then token holders may get unexpectedly diluted, resulting in losses for them.
Bitcoin, for example, has a fixed supply schedule, consisting of block reward halvings every 4 years. Ethereum on the other hand has had its supply schedule adjusted multiple times, giving ETH holders less certainty about the scarcity of their asset.
Chia’s supply schedule is fixed, but unlike Bitcoin’s, has tail emissions, which means that block rewards are a fixed amount of XCH in perpetuity after a number of initial halvings. Although this makes Chia less ‘scarce’ than Bitcoin, it addresses a critical long-term vulnerability of Bitcoin: miners having to rely exclusively on transaction fees in the future opens the network up to subtle attack vectors.² Since the degree of scarcity can easily be priced in by the market, but the ramifications of a missing security budget are much more difficult to quantify, the scarcity vs. security trade-off made by Chia ultimately makes XCH a better store-of-value asset than Bitcoin in the long run.
Custody tools
Custody remains one of the perennial pain points of owning and transacting with cryptocurrencies. To be a good store-of-value, it must be possible to securely store and transact with an asset. In crypto, this means protecting against unauthorized access to, or loss of, private keys.
Bitcoin is hamstrung due to its limited smart contract language Bitcoin Script. Although Bitcoin supports multi-sig addresses, it lacks more powerful primitives. The situation is similar with Ethereum, although not so much because of Solidity, but due to flawed token standards that require approval transactions susceptible to phishing attacks, as well as a lack of atomic swaps.
Chia on the other hand, with its secure and Turing-complete smart contract language Chialisp, supports advanced custody primitives such as clawbacks and re-key. Chia also natively supports atomic swaps for both fungible and non-fungible tokens, allowing users to safely transact on-chain.
Collateral
Store-of-value assets tend to make for good collateral assets. Large cap cryptocurrencies in particular work well as they trade in deep and liquid markets, which reduces risk for the secured party in a loan relationship if the borrower defaults on their obligations.
Another reason why cryptocurrencies are exceptionally well-suited as collateral is that they can be near-instantly transferred between counterparties, and it is straightforward to determine who controls the cryptocurrency at a given address: the owner of the corresponding private key, and nobody else.
Traditionally, if an asset is used as collateral, for example to secure a loan, any security³ provided would need to be perfected to make it enforceable against third parties. Perfecting security is a process that can take days to complete, and often involves a statutory registration, such as filing a financing statement with the relevant UCC filing office in the US, or registering a charge with Companies House in the UK. Without perfection, security is only binding on the security provider and secured party, leaving the secured party at risk from claims of, for example, the liquidator of the security provider or third party secured creditors.
In other words, perfecting security ensures that the collateral provided to the secured party is free from claims of third parties. This prevents security providers from fraudulently providing the same asset as security for multiple loans. If this sounds like the double-spend problem, then you are not mistaken. And indeed the solution that tradfi has to offer is the same in both cases: use of a central entity to monitor the system.
With cryptocurrencies, this centralized entity is no longer needed, as the collateral can be sent directly to the secured party. Although this solves the problem from a practical point of view, there is still the question of whether the law will operate accordingly. The answer, unfortunately, is that typically it doesn’t. However, in many jurisdictions changes are being made to bring the law in line with the new reality. For example, in the US the concept of Controllable Electronic Record (CER) is being introduced in the Uniform Commercial Code (UCC) for this very reason,⁴ and in the UK the Law Commission has recommended that legislation be passed to address this issue.⁵
So which cryptocurrency should one choose as collateral? From a purely technological perspective, one would argue Chia. There is, however, still a lack of liquidity and trading venues, and the small market capitalization makes it more susceptible to price volatility. The former is undesirable for the secured party as it makes the asset difficult to liquidate, whereas the latter is undesirable for the security provider as it increases the risk of liquidation.⁶ In the long-run however, as the ecosystem matures and XCH gets listed on more CEXs, Chia’s outstanding characteristics as a store-of-value asset and highly customisable custody primitives should make it a go-to collateral asset not only for individuals but also for enterprises and institutions.
[1]: The Nakamoto coefficient measures diversity amonst block builders. The high coefficient is desirable as it means that more entities, on average, are involved in the block building process.
[2]: https://www.cs.princeton.edu/~arvindn/publications/mining_CCS.pdf
[3]: In this context, ‘security’ simply means collateral and not ‘financial instrument’
[4]: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4388919
[5]: https://lawcom.gov.uk/project/digital-assets/
[6]: See the historical drawdown analysis in the Circuit documentation
