THE GOOD THE BAD AND THE STABLE- COULD THE EMERGENCE OF STABLECOINS CAUSE FINANCIAL INSTABILITY? I say yes ! But why and how?
During my talk at AIBC summit over in Malta last week I gave an overview of what stablecoins are, the type of business models that are surfacing, which stablecoins have a chance at mass adoption and explained why if adopted could potentially threaten monetary policy and cause financial instability!
However before i delved deep into the new hot topic stablecoins i went back to explaining the basic principles of economics as i think that in order to understand why stablecoins could be so revolutionary it is imperative that the public understand and are educated about the underlying principles of money currency and monetary policy.
Why are top institutional players from Central Banks such as EBA ESMA IMF G7 all meeting discussing and publishing papers about stablecoins threatening their financial monetary systems? What is all the fuss about?
Firstly lets understand what money and currency is actually all about !
To simplify the law of economics —
Firstly money is value and perception driven. Whatever thing is associated with a form of wealth which may be exchanged for goods and services can be used as money. Could be euro ethereum apples or oranges!
Money as we know it is is actually only an illusion — for every 9 dollars there is only 1 physical dollar so if everyone had to go pull out ‘their’ money at the same time it would be impossible. So money is actually just digits on our screens. So in actual fact it is not backed by anything physical but controlled through monetary policy (fed reserve requirements, supply and demand principles etc).
Many say crypto is revolutionary because it is digital. False. Most money in circulation is in electronic form. What is revolutionary about crypto is the peer to peer element (no third party involvement) which gives people full control of their own funds.
What are the main characteristics of money?
There are 3: Money needs to be a unit of account, have a stable store of value and be a medium of exchange. So one can hold store and exchange it.
Many people say ‘ahhh Bitcoin is an amazing currency because it is a medium of exchange’ — yes granted it is a medium of exchange and you can store it but what about the third requirement (stablestore of value? It is for that reason why it took off as a speculative asset and people are not rushing off to convert all their fiat to btc when today a car can cost 1 btc and tomorrow 10btc.
Besides these 3 money traits there are two other conditions which need to be present for money to be adopted as a currency :
Price Stability & Mass Adoption.
Ok now that we’ve covered the basics of the laws of economics — lets move on. What are stablecoins?
Stablecoins are cryptoassets which derive their stability from an underlying asset. Developers and crypto enthusiasts have realised that in order for crypto to be adoped and used as a means of payment they need to be stable.
In come the emergence stablecoins !
There are currently four main types of stablecoin business models. These are:
- Fiat backed — stablecoins backed by traditional currencies such as dollar (tether) and euro (stasis).
- Commodity backed — these could be oil (petro), gold (digix) silver or other precious metals.
- Collateral backed- coins backed by other crypto such as Maker Dao (Dai) backed by ether
- Seignorage backed- this has a business model which works like a decentralised bank and algorithmically applies supply and demand principles just as central banks do in their monetary policies.
The last model Seinorage style stabelecoins is the best in terms of being fully decentralised and having no connection to central bodies however these may be a bit complex to understand for the ordinary man in the street so it is understandable that stablecoins with an underlying asset they know (such as fiat or gold) will be adopted faster.
Are any of these stablecoins being adopted? Could the crypto industry have cracked the code now that it has caught up with the laws of economics?
Although there are quite a few stablecoins gaining a significant amount of traction such as trueUSD Dai Stasis Carbon etc. There is one true leader of the pack…
Yes i am sure you guessed it: LIBRA (facebook stablecoin).
Going back to the conditions a currency needs to survive (stablility and mass adoption) Libra derives its stability from a basket of fiat currencies and has a user base of 2.7 billion customers!!
It is no wonder that Governments and central banks are in panic mode and want to shut down or control the emergence of stablecoins especially Libra.
If stablecoins become more used then sovereign currencies, current montetary policies will be severely undermined.
In order not to be left out from this potential shift Central Banks are responding with CBDCs (Central Bank Digital Coins). According to the BIS 70% of the worlds financial institutions are conducting research about CBDC and some are already working on building and implementing such systems .in fact the people’s bank of China have publicly admitted that the announcement of Libra sped up their operations to launch their CBDC and recently the ECB have stated that they are working on a European CBDC!
However do not be fooled. A wolf in a sheeps clothing is still a wolf and CBDC will still require central banks approval to transact unlike stablecoins which transact on a peer to peer basis.
In the words of Milton Friedman — “He who controls the supply of money controls the nation”
We are therefore dealing with governments very core bread and butter — their economy!
Stablecoins are truly revolutionary and if adopted could also provide financial inclusion to the 2 billion people around the world who do not have access banks!
Who will win in the battle between David (stablecoins) versus Goliath (central banks)? And how ugly will the battle get?
About the author- This piece is written by Dr. Justine Scerri Herrera — a warranted Maltese Lawyer (LL.B, LL.D, LL.M) with a background in banking and finance and who is currently specialising in licencing and advisory in the crypto space. The author is an academic at heart and also a true believer of the crypto movement. She regularly publishes papers and speaks at international events about how and why crypto and blockchain intertwines and is being leveraged by players from the financial industries and capital markets.
She works at a top tier international firm Michael Kyprianou (https://www.kyprianou.com/en/index.html) and is a Director of MK VFA Agents entity (part of Michael Kyprianou group).
Stay tuned for Justine’s next article titled: “How and Why are Capital Market players leveraging DLT?”