Stable money is good for people, good for economies and good for nations. The last time the world had stable money was in 1971 before President Nixon took the US off the gold standard. The result of that act was rampant inflation, the loss of real wages and lower economic growth. If these benefits can be returned it means a return to stable money, that is money that buys the same goods in 5, 10, and 30 years’ time as it does today. But how can this be done?
In May this year I launched Saver Token as the first stable money since 1971. In another article I have outlined why Saver Token tracks the US Consumer Price Index (CPI-U) instead of gold as the basis of its stability. Here I want give some background to the non-collateralised way Saver Token keeps its peg to the CPI-U. I then want to stress-test the approach in various challenging environments such as a hack to the blockchain, war, speculative attack and economic collapse to evaluate how robust the non-collateralised approach is compared to the collateralised approach more commonly used today.
What is a peg?
A peg is a way of keeping the price of a currency at the same value as something else. For example the Hong Kong Currency Board keeps the Hong Kong dollar pegged to the value of the US dollar. In this case the peg is to another depreciating currency. However a peg is also required for stable money. When people talk of the gold standard era what they mean is the period in the 18th, 19th and 20th centuries when currencies were pegged to the value of gold. Because the value of gold was stable this meant that the value of the currencies were also stable.
There are essentially two ways for a currency to maintain a peg:
A collateralised peg
A collateralised currency means a currency that has sufficient reserves (collateral) so that is can buy back its own notes in order to reduce supply of money if the currency falls below its pegged value. The idea is that reducing supply restores the supply/demand balance at the pegged price. Currency that is bought is removed from circulation.
Supply also works the other way. If the value of a currency is higher than the pegged price, the issuer can sell more of the currency into the market to increase supply. They continue to do this until the supply/demand balance is again restored at the pegged price. In this case, when the issuer is increasing supply, no collateral is needed; they simply print and issue more of the currency.
The Hong Kong Currency Board keeps the Hong Kong dollar pegged to the US dollar in this way. If the Hong Kong dollar loses value so that more Hong Kong dollars are needed to buy US dollars then it buys Hong Kong dollars using its reserves and removes the money from circulation. The reduction in supply eventually restores the Hong Kong dollar to its peg with the US dollar.
If the Hong Kong dollar strengthens against the US dollar so that one Hong Kong dollar buys more than one US dollar the Currency Board reverses its behaviour and starts selling newly created Hong Kong dollars. This increases the total supply of Hong Kong dollars and continues until a point is reached where there are no more buyers of Hong Kong dollars at a price above the peg price with the US dollar.
The beauty of this collateralised approach to maintaining a peg is that it is entirely mechanical. There are no experts required to decide what to do in any situation. There is no discretion. It is an entirely automatic process. The supply of the currency is used to maintain its value at a pegged price.
The elegance of the approach has also been proven in practise. Money was kept stable during the gold standard era, the most prosperous time in human history, using this approach. Today Exchange Traded Funds, such as like SPDR Gold Shares use the same approach, as do digital currencies called stablecoins like Tether when their value is kept pegged to a fiat currency through redemptions in that currency.
However, there is more going on with the collateralised approach to a peg than at first meets the eye. Indeed is the control of supply the only, or even the main, way the peg is being maintained?
Is the management of supply all that is maintaining the peg?
Economists wish to elevate supply and demand to the status of a physical law like gravity. However economics has to do with human interaction. Money itself is a human artefact like language. This suggests that when we are looking to maintain a peg for a currency we are not dealing with hard science.
Consider the following.
The stable value of gold
Gold, along with silver, copper and bronze, was being used as a unit of account and means of exchange at least two thousand years before the invention of the first coins in Lydia in the 8th Century B.C. The metals were measured by their weight. This weight came to represent a stable value. The stability of value made it possible to trade, for example, 3 sheep, worth 2 ounces of gold for 50 bricks also valued at 2 ounces of gold. It was this stability that made the expansion of trade possible.
But what gave the metals their stable value? No one was actively managing supply and demand of these metals for two millennia and yet the peg of a stable value held. The most obvious answer is that people needed a stable unit of exchange. This need, and the metal’s utility for the purpose, created the stability.
In theory a collateralised method of maintaining a peg requires 100% of the value of the currency to be backed. For example, if $1 million dollars of a currency is in circulation, theory suggests it needs to have to $1 million of collateral (assets or reserves) backing it.
The reason for this is that if speculators believe the issuer of a currency does not have either the determination or the collateral to defend its pegged value, they will short the currency to the point where the issuer capitulates.
This is exactly what happened when George Soros made his famous bet against the Bank of England. Soros believed the Bank did not have the resources or political determination to keep the pound pegged to is range of values in the European Exchange Rate Mechanism (ERM). He was right. On 16 September 1992, John Major’s Conservative government was forced to withdraw the pound sterling from the ERM after it was unable to keep the pound above its agreed lower limit.
Given the threat from speculators you would think that instruments that are pegged would always be backed with 100% collateral. Certainly many make this claim including central banks, SPDR Gold Shares and redemption-based stablecoins like Tether.
That is the theory. In practise things look quite different.
The Bank of England
The Bank of England was itself established in 1694 with the explicit purpose of providing a £1.2 million at 8% interest to King William to fund his war with France.
To do this the bank issued £2,011,032 of notes so its balance sheet looked like this:
 Nathan Berg, Gold the Final Standard p.22.
 Nathan Berg, Gold the Final Standard p.69
Notice that the total amount of coins and bullion the bank had was just £258,358, a mere of 10.7% of notes issued. On paper it looked like the bank had the 100% assets to maintain the pound’s peg to gold. Assets matched liabilities. But in reality the money was backed with just the 10.7% of coins and bullion.
In theory it could sell government debt on the open market to buy gold if people wanted to trade their notes for gold at the pegged price. However there would been very few buyers. The entire reason for the bank’s formation was to extend loans to the government that no-one else was willing to provide except in small amounts and at interests rates of 14% or higher.
The gold standard thus began with just 10.7% of available collateral to maintain the peg of the pound to gold. It was enough and ushered in 228 years of stable money. But the event showed there was more to maintaining the peg to gold than just holding collateral.
One key factor is likely to have been confidence people had in the bank. On Tuesday 2nd January 1692 Charles II had defaulted on the repayment of government debt in the famous “Stop the Exchequer”. The event had ruined the prominent goldsmith bankers as the government also refused to return the gold that had been entrusted to it, in effect robbery. The result was deep distrust in the government’s ability or desire to honour its obligations. With this background, the Bank of England, as an independent private company inspired much greater confidence, confidence that is likely to have played a major role in maintaining the peg of its notes to the value of gold.
Tether is by far the largest stablecoin in the digital currency space. It is also the most controversial. While in theory the company has 1 US dollar backing every coin it issues (100% collateral) during 2018 and this year there have been continued rumours that the coin is not backed 1 for 1.
During 2018 Tether also lost its banking relationship for a time making it impossible for them to make redemptions into fiat. If the active management of supply was the primary way Tether’s coins were keeping their peg with the US dollar the inability to make redemptions should have meant a loss of that peg. What happened? Very little. The value of Tether continued to be stable against the US dollar.
More recently Tether has been under investigation by the New York Attorney General’s Office for alleged fraud. If found guilty the courts could seize Tether’s assets removing all collateral from the coin. What threat has this made to Tether’s peg? Again very little.
 Nathan Berg, Gold the Final Standard p.69
Clearly something more than 100% collateral is responsible for the peg’s remarkable success despite all the events surrounding Tether.
Stablecoins play a critical role in the crypto currency eco-system. They enable people to on-board from fiat currencies. Because their value is pegged to fiat currencies such as the USD and the Euro they are also far less volatile than most crypto currencies. This makes them safe havens for speculators to park their assets between trades.
Tether was the first stablecoin. Much of the strength of its peg is likely to lie in the need people had for a coin like Tether in the crypto currency space. Because there was need for the peg to work it did. In this case the need provided the peg even when redemptions (management of supply) were suspended and the likelihood that Tether coins are not 100% collateralised became known. That need continues to hold the peg today in the face of the regulatory risk that Tether’s USD assets could be frozen.
So what maintains a peg?
With the above examples I am not suggesting that the active management of supply is not an effective mechanism for maintaining a peg. The Hong Kong Currency Board is often cited as the model case. In March 2019 its base money had 254% collateral backing it making its peg to the US dollar resilient to even the most persistent speculative attack.
However collateral for the active management of supply is clearly is not the only factor maintaining a peg. We have seen others such as:
· Need and expectation (gold before coinage, Tether)
· Confidence and trust (Bank of England)
These highlight the role people play in the maintenance of a peg. Pegs are able to be maintained by people’s expectation, their need and their confidence in an authority they trust.
One of the challenges of attempting to evaluate the relative effectiveness of the active management of supply compared to a peg based on human attributes is that the human attributes are always present whenever there is the active management of supply. There can be no example of an active management of supply peg that does not also have components of expectation, need, confidence and trust.
This unwavering presence of human attributes begs the question which approach is contributing most to the effectiveness of a peg. Could it be that, despite initial appearances, the human factors actually provide most of the effectiveness? We will probably never know.
The converse however is not true: the non-collateralised approach has been shown to work even without the active management of supply (gold before coinage, Tether when it lost its banking relationship).
I am calling the human element to maintaining a peg the non-collateralised approach. All collateralised approaches incorporate elements of the non-collateralised approach whether they like to admit it or not.
The non-collateralised peg
Is the non-collateralised approach enough to maintain a peg? Yes. It was the basis of stable units of exchange until the 8th Century B.C. It is also a major factor in Tether’s continued peg to the US dollar.
Saver Token has taken the non-collateralised route to its peg with the CPI-U. In doing so it has adapted these human attributes to the expectation of the Bitcoin era we now live in. This means two things,
· confidence in people rather than institutions.
People are waking up to the fact that the base money of central banks is created from nothing. They are also increasingly aware of inflation as an indicator of the mismanagement of the money supply by the same institutions. This has contributed to a loss of confidence in centralised authorities when it comes to the management of money and its stability.
Coming into this environment in the aftermath of the 2008 Financial Crisis Satoshi Nakamoto invented Bitcoin, a currency where there was no need to trust any centralised authority. The price of Bitcoin today is testimony to how much people value this attribute — they would rather trust themselves than a central bank.
Saver Token takes this “In Ourselves We Trust” sentiment one step further by explicitly stating on the website that not only do people give value to the currency, they are also responsible for maintaining its peg to the CPI-U.
Saver Token has adapted the non-collateralised approach to people’s current needs and expectations. In 1694 and the formation of the Bank of England people had confidence and trust in private institutions to manage money. Today people have confidence in and trust themselves. Trust and confidence are still at the basis of the peg, only the focus has changed.
The approach can also be called enlightened self-interest. Because Saver Token is explicit (open) about the non-collateralised basis of the peg to CPI-U, people will only buy the currency if they are committed to using it at this stable value. Indeed there is no other reason for owning Savers. Because it is in everyone’s interest, the peg is likely to be maintained.
Why has Saver Token taken the non-collateralised peg approach?
There are a number of reasons why Saver Token has taken this approach to its peg with the CPI-U.
The first is necessity. In a world of depreciating currencies, what would Saver Token hold as assets to cover redemptions? Other currencies will continue to lose value relative to Saver Token as inflation erodes them. An alternative would be to invest funds received from the sale of tokens in the hope of providing returns greater than the rate of inflation. However this would make the robustness of Saver Token dependent upon the robustness of the trading strategy adopted. Good investment strategies may work for 5 or 10 years but what about 200 years? They may also be able to outperform inflation at 2% p.a. but when inflation reaches 10% or 15% p.a. the stability of the token is stressed at the time when a stable currency is most needed. Collateralisation for stable money when government issued money continues to depreciate is not a working option.
Having token holders maintain the peg enables Saver Token to be as independent as possible from external factors that could affect its stability. Bitcoin achieves the same effect in relation to its value. Because the value of Bitcoin is wholly the creation of its users, Bitcoin’s value is independent of the financial system. If the financial system collapsed tomorrow this would not mean the end of Bitcoin and the value stored in the coins.
Bitcoin’s is also independent of any centralised authority. Compare this to Tether, where the value of the coins depends upon a redemption process that involves the Tether company and its bankers. The counter-party risk poses a threat to Tether’s peg which I have suggested is currently being maintained primarily by non-collateralised factors.
Having responsibility for Bitcoin’s value vested in coin holders themselves is a far more robust solution. The source of value creation is distributed among all coin holders. Like the Internet itself, this makes Bitcoin’s value resistant to most attacks. If a few people panic and believe Bitcoin’s value will fall to zero, the rest of the system, composed of people who still believe in its value, remains. It is no co-incidence that the Internet was originally conceived as a communication system capable of withstanding a nuclear attack — distributed systems are remarkably robust.
Given that we know that people can maintain the stability of money, it makes sense to vest Saver Token holders with the responsibility do so. All the benefits of a distributed network come into play. If some token holders panic and seek to sell tokens at below the pegged price, this is unlikely to affect the system as a whole. Responsibility for the peg resides in each token holder.
While Saver Token has a company that issues new tokens, the value of the tokens and their peg to CPI-U does not depend upon the existence of the issuer. If no new tokens were issued the stability of the tokens already in circulation would not be affected. It would simply mean that there could be no expansion of supply.
Skin in the Game
As well as having the resilience of a distributed network design, giving responsibility to token holders to maintain the peg of Saver Tokens also has the benefit of giving that responsibility to those who have most to lose if the peg is broken.
Token holders have the greatest “skin in the game”, and hence the greatest commitment to maintaining the peg. It is in their interest to maintain the peg as this is what gives Saver tokens their value.
Self-interest is a very strong motive. It is the same motivation that gave gold its stable value for thousands of years — the need of people for a stable means of exchange.
Testimony to the efficacy of self-interest is not hard to find in history. For example, in the autumn of 1922 hyper-inflation was so rampant in Germany that the country was on the verge of civil unrest. Over 2,000 alternative currencies were in circulation in an effort to find some means of exchange that was not depreciating as fast as the German mark. Into this chaos the government issued a small amount of what it called “Gold Loan Bonds”. The notes had no more collateral than the hyper-inflating mark. Nor was their supply adjusted to maintain their value. However they were accepted by the population and indeed held their value. The reason was one word printed on the notes: “wertheständig” (stable-value). 
By taking the non-collateralised approach Saver Token gives responsibility for the peg to those who can be most relied upon to defend it.
Trust can easily be broken. After the “Stop the Exchequer” in 1692 few people wanted to trust their monarch with their money. The same is happening today with people’s faith in governments and their central banks. Much of the appeal of Bitcoin is that people are asked to trust no-one except themselves for the maintenance of the currency and its value.
Saver Token is explicit about what gives the tokens value and what maintains their peg. It is present in black and white on the front page of the website. In effect Saver Token follows the lead of Bitcoin in creating “trustless” stable money. Or, to put this another way, people are only being asked to trust themselves. This approach is the application of the same mechanisms of trust and confidence that worked so well at the incorporation of the Bank of England tailored to the today’s environment.
By way of contrast collateralised methods of maintaining a peg are increasingly coming under scrutiny and through that analysis trust and confidence are being eroded. If these human characteristics play a major role in maintaining a peg then the collateralised approach may not be as robust as it once was.
For example, the SPDR Gold Shares prospectus gives the Trustee the right to suspend redemptions:
“The Trustee may, in its discretion, and will when directed by the Sponsor, suspend the right of redemption, or postpone the redemption settlement date…[and that] none of the Sponsor, the Trustee or the Custodian will be liable to any person or in any way for any loss or damages that may result from any such suspension, postponement or rejection.”
Stress testing the Saver Token approach
The non-collateralised approach to a peg may look good on paper but how will it perform in the uncertainties of a real environment? Let us look at how Saver Token’s peg is designed to meet some these challenges.
As Black Monday showed, a speculative attack on a collateralised peg succeeds if the issuer lacks the collateral and/or the discipline to withstand it. With a non-collateralised peg there is no collateral so the amount held is not an issue. Instead the success of the attack depends upon the discipline of those maintaining the peg.
In the case of Saver Token, this discipline is not vested in a single authority. The history of money can be read as the repeated failures of a vested authority to have the discipline to maintain the integrity and stability of the currency. The inevitable result has been debasement and inflation leading to collapse.
There is no question in my mind that discipline is essential in maintaining the stability of a currency. With Saver Token this discipline is vested in every token holder. The need for discipline is distributed eliminating any single point of failure. Also, as each token holder has a vested self-interest in maintaining the peg of the system the need for discipline is given to those most likely to defend it. Any general knows that people fighting for their homes and family are a more determined force than conscripts.
The discounting of the token by a few does not change that self-interest. Only if all token holders believed the system had experienced catastrophic failure would it be in their interests to sell their tokens at a discount in order to recoup some of their value.
Catastrophic failure can of course happen to any system. The most obvious example for Saver Token or any distributed blockchain currency is a bug in the blockchain code that compromises its ability to record ownership and facilitate transactions. These “black swan” events cannot be ruled out and no system can be fully immune to their possibility. However if we look at some “catastrophic” scenarios it becomes clear that, perhaps surprisingly, the non-collateralised approach carries significantly less risk as the collateralised approach.
Like Bitcoin, the value of Saver Token, and its peg, is entirely vested in token holders. External threats such as war, unless it destroyed the Internet, would not in itself render the currency valueless. However war is a major reason for the demise of fiat currencies tied as they are to the fate of nations.
If Tether’s assets are seized by the New York Attorney General’s Office the collateralised method of maintaining Tether’s peg to the US dollar has failed coin holders. It may take years to have the assets unfreezed if at all.
Tether’s vulnerability lies is both having collateral, and by having a company and bankers. This gives regulators a target. In a system like Bitcoin or Saver Token where value is decentralised on the blockchain in the form of individual holders of the currencies there is neither any assets to seize or a clear target to regulate. Saver Token has a company issuing the tokens. However, as noted above, the value of tokens in distribution does not depend upon the issuer. That value is vested in the blockchain so that even if the issuer was in some way to fall prey to regulation the issued tokens could still trade at the peg price.
Tether banks with Deltec Bank & Trust Limited based in the Bahamas. The strength of the coin’s peg to the US dollar depends entirely upon the reliability, integrity and regulatory environment of this little known bank. Is this the most resilient means of maintaining a peg?
In contrast, with no collateral required to maintain its peg, holders of Saver Token have no counter-party risk.
If there is another collapse of the financial system along the lines of what happened during the financial crisis of 2008 the dependencies of the system mean that any institution that is part of that system may be affected. For example with SPDR Gold Shares:
“World Gold Trust Services, LLC is the sponsor of the Trust, or the Sponsor. BNY Mellon Asset Servicing, a division of The Bank of New York Mellon, is the trustee of the Trust, or the Trustee, HSBC Bank plc is the custodian of the Trust, or the Custodian, and State Street Global Advisors Funds Distributors, LLC (formerly State Street Global Markets, LLC) is the marketing agent of the Trust, or the Marketing Agent.”
If any of these organisations becomes insolvent as a result of the cascade effect of a single institutional default rippling through the financial system the value of SPDR Gold Shares could fall to zero as shareholders are unable to redeem their gold. The truly un-nerving part of systemic risk like this is that the peg of SPDR Gold shares to the price of gold could collapse through no fault of the sponsor or any of its affiliates. The trigger for collapse could be in Greece, US student debt, volatility trading or any of the current contenders.
Like Bitcoin, Saver Token’s value and peg is held entirely by token holders on the blockchain. There are no dependencies that implicate it with the financial system. This makes the stability of its value immune from the threat of economic collapse.
Which way to maintain a peg?
In summary we can say that pegs have been maintained through two approaches: collateralised and non-collateralised. The non-collateralised approach is always present even in a collateralised system. However the non-collateralised approach has also been shown to work independently of a financial product being backed by collateral.
Saver Token has taken the human attributes of need, expectation, confidence and trust that represent the non-collateralised approach and adapted them to the realities of the Bitcoin-era.
While no currency is immune to catastrophic failure, the non-collateral approach has distinct advantages over the collateralised approach by reducing the risk the users of the currency face. In particular the risk of speculative attack, war, regulation, counter-party risk and economic collapse are minimized by the approach. I believe this reduction of risk is an essential component for a currency that wants to provide stable money for 5, 10, or 100 years.
 Constantino Bressciani-Turroni, The Economics of Inflation pp. 341–354 abstracted in The Institute of Economic Affairs 1976.