Stablecoins
I listened to this a16z podcast about stablecoins and decided to research further into them. This is what I found.
First, let’s state exactly what a stablecoin is — a cryptocurrency whose value is tied directly with an asset that has a stable value like gold or fiat money.
Types of Stablecoins
1. Fiat-Backed Stablecoin
These stablecoins are backed 1:1 with fiat currency as $1 USD to 1 token. The most prominent example of one is Tether (USDT), whose value is $1 USD for every USDT token. The only way to legitimize that the currency is actually backed 1:1 is by auditing the authority issuing the token or blindly trusting them. This seems like the opposite of how cryptocurrencies are supposed to be governed.
2. Commodity-Backed Stablecoins
A commodity is a raw material or primary agricultural product that can be bought and sold. The most common type of collateralization in our society is gold. A unique case study of a commodity-backed stablecoin is the Petro which was issued by the Venezuelan government because its fiat currency, the Bolivar, experienced hyperinflation. The currency appears to be a scam as there is no source code available to prove the legitimacy of the coin.
3. Cryptocurrency-Backed Stablecoins
This is a stablecoin that is backed by a mixture of known cryptocurrencies like Bitcoin or Ethereum. The most interesting project that the A16Z podcast talked about was the MakerDAO (DAI) project. The point of the project is to provide “stability for the blockchain”. To be able to sell services on the blockchain, you need a stable medium of exchange or else people won’t want to sell any of their services. Additionally, the project aims to provide the existing wealth in the world to be shared among all parties. For example, if you look at the players in a supply chain network, the big centralized parties are the ones whose market needs are being met. On the peripherals of the network, like a fisherman who is the one actually providing the goods the network is moving, is not able to secure the credit they need to survive. This is what the project aims to solve — provide high-quality financial tools to everyone in the network by building an equal opportunity to access money in the future as debt through cryptocurrencies.
What is DAI?
It is a system of smart contracts that incentivize people to lock up their crypto assets in a smart contract as an escrow and issue DAI against that asset. This is basically how our credit system works today without any centralized players like banks. The debt is repaid with a fee or interest on the loan. The unique part of this loan is that any type of asset can be used to back the DAI. This means that if one type of asset fails, the network still survives. This type of trustless network built on smart contracts is unique in that no single party administers the running of code. The smart contracts are executed only if the conditions of them are met.
A caveat to this is that smart contracts need to be developed with a hardware-type mentality. For example, when a company manufactures a semiconductor, it ensures that all of the situations that the semiconductor might face have been tested so that it is guaranteed to not fail. Failure would mean a massive loss for the company and they would need to start over. This is the same mentality that is needed to develop smart contracts. You need formal verification of all possible realities that the smart contract operates in and will behave in the way you expect it to. Otherwise, the governance system that is enabled by them will fall apart and the network will fail. I thought this was the most interesting point that was brought up in the podcast. Normally, software developers like to “move fast and break things”, but with smart contracts, you need a very different mentality that will consistently work every time in any situation.
