Stable coin is an interesting creature.
On one hand, it’s very simple and straight forward. 1 stable coin (e.g. USDC or Pax) represents 1 USD in the bank, which can be used for global remittance and payment just like cash in your pocket, but with a lower cost and faster process time (thanks for blockchain technology). Every people on the street understands how this works.
On the other hand, it is quite complicated. The complicated monetary systems from the real world (e.g. central banks, commercial banks, capital markets, derivatives, etc.), and all the benefits and problems associated with them, applies perfectly well to the stable coin since it’s strictly anchored to fiat currency. Most people on the street don’t’ really understand how this works. As a matter of fact, even people from Wall Street don’t quite understand how this works fully, and that’s why we have repeated financial crisis.
Due to the interesting nature of stable coin, it somehow creates a “virtual monetary system” that is parallel to the “real-world monetary system”. In this “virtual monetary system”, due to the lack of legacy setups, monopoly powers, rules, laws and regulations, money could be managed, used and leveraged in very different ways from the real-world. This will lead to emergence of new opportunities and arising of new powers, which would otherwise be impossible in the highly regulated and competitive real-world economy. And because stable coin is anchored 1:1 to fiat currency, the emerging new power will ultimately impact the real-world economy, in either a good or bad way that no one is certain about.
At the moment, there are 3 groups of people who are issuing stable coins. There will be the 4th group in future.
Group 1: Scam. They issue their own stable coin and claim it’s backed by 1:1 by fiat currency, which is not. In worst cases, it’s backed by nothing. USDT could be a live example, although I hope it’s not. This is like printing money and ultimately becomes a pyramid scheme. As long as they can keep convincing new people to believe in the story, buy and hold those stable coin, the party goes on. This may sound crazy but we should never underestimate the dark side of human nature when big commercial incentive is at stake. The ponzi scheme created by Madoff is another good example (although not from crypto industry). And if we look at the crypto market and ICOs in the last 12 months, it’s not over-exaggerating to say that most of the projects are actually scams. Anyway it’s normal to see scams in any markets that are in early stage, which is not specially pertaining to the blockchain/crypto industry.
Group 2: Crytpo Project. They issue stable coin to be a bridge between crypto industry and fiat system, and solve the burning problems of the crypto trading process. For example, in many countries like China, local people can’t buy crypto using fiat currency since the bank doesn’t support it. Stable coin partially solves that problem. There are clear incentives and business logics behind these stable coin initiatives. They either want to better grow the core business (mostly crypto exchanges like USDT/USDC), or acquire customers as much as possible, by addressing the pain points, and figure out the monetization strategy later (e.g. Paxos, TUSD, MakerDAO). In general, this group of stable coin issuers intent to bring new customers into the crypto industry and help the industry to grow.
Group 3: Big Companies like JP Morgan and Facebook. When big companies are entering the crypto industry, they typically have a well-thought strategy which is linked to their existing business. To understand their intentions of issuing stable coin and predict their future moves, we have to look into each company’s business in depth. But one thing for sure, considering the size of traditional capital market which is much bigger than crypto industry, the entry of these big companies will create serious impact and competition for those stable coins issued by crypto projects as mentioned above.
JP Morgan recently issued their own stable coin JPM Coin, which is anchored to USD and will be used in the bank’s internal ecosystem (within the bank and among other companies doing business with bank). On their website, JP Morgan claims the purpose of JPM Coin is to facilitate instantaneous payment. Many people are comparing JPM Coin and Ripple, and trying to figure out which solution is more efficient in terms of global and cross-company settlement. While this is an interesting discussion considering the fact that blockchain technology is born to improve the efficiency of multi-party collaboration, in my view, by no means it scratches the surface of JP Morgan’s real intention of issuing the stable coin. The logic is quite simple. If JP Morgan wants to improve the global settlement efficiency, their IT department can just use blockchain technology to build a settlement system (like what Ripple is doing), which is not difficult to implement at all. Why do they even need to issue a stable coin, and make big announcement about it?
Facebook’s recent announcement of FB Coin (Facebook’s version of stable coin) make the situation more interesting. Just as we questioned in above paragraph, if the benefit of stable coin is merely to facilitate efficient global payment and settlement, why Facebook, who is not even a bank and doesn’t have any existing banking operation, wants to issue their own stable coin? Do they also want to improve operation efficiency? And why is Facebook CEO Mark Zuckerberg paying so much attention to FB Coin, if the sole purpose is just to improve payment speed and efficiency? Does Mark Zuckerberg see something else that we don’t?
The answer is too all these questions is quite obvious. Stable coin is more than an efficiency-improving IT solution. It must come with commercial interests that are significant enough for top management in big companies (JP Morgan and Facebook for now, more in future) to see it as landscape changing and paradigm shifting, and push the agenda top-down. Where are these significant commercial interests coming from, since it’s not from the costing-saving by adopting blockchain technologies? What is the real business logic of stable coin that Mark Zuckerberg sees?
Before we answer this question, let’s refresh ourselves with the fundamental formula between money supply and economic activities, MV = PQ. As explained in more details in below picture.
The multiple of Money Supply (M) and Velocity of Circulation (V) is GDP, which is also equivalent to the Price Level (P) and Economy’s Output (Q). This equation is mostly used to understand the general direction of macro economy development, and seldom used for micro economic activities related to particular companies or individuals. But with stable coins now in picture, the equation has different interpretation. Let’s look at a particular business scenario to understand further.
1） A is an individual based in Singapore and has been a Facebook user for 5 years. A exchanges 100 USD to 100 FB Coin and put it into his Facebook wallet. B is a small business manufacturing Electronic Cigarette based in USA and has been a Facebook merchant for 5 years as well.
2） A transfers B 100 FB Coin to buy B’s product. The whole process is very similar to any other E-commerce websites.
3）B receives 100 FB Coin. B deposit 50 FB Coin into a Crypto Bank, who is Facebook’s business partner, and generating 5% interests (higher than what he could get from a normal bank). These 50 FB Coin will be used to cover operating expenses like paying salaries. B transfers the remaining 50 FB Coin to his supplier C as 50% down payment for the next batch of spare parts, with the remaining 50% to be paid 30 days after spare parts are delivered.
4） D works for B. He prefers to get his salary in FB Coin, since the FB Coin delivers higher interests rate and most of his payment (e.g. rental, super market or restaurant) can be made by FB Coin (who doesn’t have a Facebook account, anyway).
5） The supplier C receives the 50% down payment from B, produces the spare parts and delivers to B after three months. While C is waiting for B to pay the remaining 50% balance in another month, C discounted this Account Receivable to the Crypto Bank and get cash immediately. Because all transaction details are on blockchain, the credit rating and fund approval is real-time and cost of funding is less than a normal bank.
6） The activities described in above 5 steps are repeated upstream along the supply chain.
In the above business scenario, within Facebook’s ecosystem, 100 FB Coin created a GDP that is way more than 100 USD. It is driven by two types of activities: Trading (buy and sell electronic cigarettes/spare parts, pay for rentals, buying dinner, etc.) and Financing (deposit, discount, payment terms). If we go back to the equation of MV=PQ, Trading improves V (more trading means faster circulation of money) and Financing improves M (more financing means more money is pumped into the ecosystem). For Facebook, with a fixed amount of FB Coin issued, in order to improve its ecosystem’s GDP, it just needs to encourage more Financing (M) and more Trading (V).
It’s relatively easy to understand the more trading will result in faster money circulation(V). The more customers and merchants are connected to Facebook ecosystem, the more business scenarios will be able to happen there. Facebook already has 2.7B users globally and if all of them trade and settle with each other using FB Coin within Facebook ecosystem, this will bring a huge GDP that is almost as big as a country. A small transaction fee from all those transaction (analogy to tax) will bring enormous commercial benefit for Facebook.
Financing needs a bit more explanation. In the modern theory of macro-economics, money has two definitions: M1 and M2. To put it simple, M1 is what people understand as “money” or “cash”, which is spent during consumption. Stable coin is certainly M1 since it’s strictly anchored to USD. M2 differs from M1 in terms of “Money Multiplier”. For example, 1 USD is deposited into the bank, which is later loaned to another party. That party deposits the 1 USD into the bank again, which is loaned to the third party. During that process, the total money created and circulating, is apparently more than 1 USD. In real world, the “Money Multiplier” is around 5, which means for every single unit of money minted, 5 units of money will be circulating in the country (for various kind of business activities). Apparently M2 makes no sense for any individual or business since they only care about how much money they own and can spend, which is M1. But M2 is very important to big economic entities, being a country or Facebook, whoever issues their own currency. In the equation MV=PQ, M is actually M2. But FB Coin, as explained above, is actually M1. Few people can notice the difference but this is crucial. In other words, for every FB Coin that Facebook issued, there will be 5 FB Coin created and circulating in Facebook ecosystem. The extra 4-dollar-difference between M1 and M2 is apparently another big source of commercial benefit for Facebook. If this sounds familiar to you like the central bank/commercial bank system, you are right. Facebook as a company is creating their own central bank in the “virtual monetary system”.
We are done with the left hand side of the equation MV=PQ. Now let’s look at the right side of the equation: P & Q. P is particularly interesting. As Facebook economic is booming and demand is going strong, there will be many orders from Facebook ecosystem to the sellers. But sellers can’t increase their price in FB ecosystem because FB Coin is anchored to USD. Any imparity of pricing between FB ecosystem and real world will result in arbitrage opportunity and impact the sellers. As a result, the fast growing of Facebook ecosystem will not result in inflation, which is big advantage of stable coin compared to another currency issued by a small country. The end result is that many transactions in the real world will be shifted to Facebook ecosystem. The nature of this paradigm shift is due to the higher efficiency of Facebook ecosystem (driven by technologies like blockchain) than the real world, which has too many dis-functional bureaucracy and legacy issues. Thanks to blockchain technology, Facebook can transform itself from Web 2.0 era (selling advertising in information web) to Web 3.0 era (creating its own value and economy). And that transformation is probably what really excites and motivates Mark Zuckerberg.
Apparently stable coin itself is not enough to build a virtual economy (supposed to be better than existing dis-functional economy system), many other infrastructures will be needed such as Personal Identification, Privacy Preservation mechanism and governance model, which are exactly what Facebook has been reported to focus on in last few months. Putting all these pieces together, we now have a better idea about what Facebook is trying to achieve. Does this sounds a bit like the plot in the movie “The Matrix“? Yes it does.
As mentioned in the beginning of the article, stable coin opens the door to a “virtual monetary system” which creates value in a different dimension from the real world economic, and later on impact the real world economy. When companies like Facebook and JP Morgan are creating their own virtual economy starting from issuing stable coins, they immediately have an edge compared to their peers as they are competing in a different dimension. This answers the ultimate question we asked before : why big companies are issuing stable coins. They do this to create strategic competitive advantages that will change the landscape and redefine the company and business in the upcoming Web3.0 era.
As an investor, making money is good but not enough. We need to know who the money is made from. If Facebook succeeded and made huge profit, who are the losing parties?
The losing parties are the 4th group of stable coin issuers as mentioned in the beginning of the article: Governments and Central Banks. They haven’t done much so far but ultimately they will have to come to the playground, if not forced to. As we all know, the world’s economy is run by government and central banks. All fiat currencies are printed by central banks and circulating in the economy that is regulated and governed by governments, who collect taxes. Now with the stable coins and a more efficiency virtual economy created, a growing portion of fiat currency and circulation disappears from the traditional banking system and shifts to blockchain-based virtual economy, which is run by companies like Facebook, and most likely will never flow back. This effectively pokes a hole in the well-established USD-dominated global currency system. In this case, Facebook somehow plays central bank’s role and reaps the benefit, without taking the corresponding responsibilities of the central bank and government. How could governments or central banks not be cautious and start to intervene? It’s just a matter of time before various central banks start to issue stable coins (or digital currency) and reclaim their authority and dominance in the virtual economy.
Let’s talk a bit about blockchain technology or DLT (Distributed Ledger Technology) in general. All things we discussed above are not possible without blockchain. As we all know, blockchain as a public ledger creates trusts among distributed parties. Without blockchain, in order for two unrelated parties to transact, they will need intermediary parties like lawyers, banks and governments. Over time these intermediary parties gain power and become monopolies, with little incentive to improve efficiency. Blockchain allows the two unrelated parties to create trust and transactions with each other, with less help needed from intermediary parties (but not replacing them). This creates competition to the inefficient legal systems and push them to improve, which is good for the society. Let’s take FB Coin for an example. Let’s imagine FB Coin is created without blockchain technology, and just a number showing your cash balance in Facebook account. You have to use it for internal transfer among Facebook users. In that case, FB Coin is less attractive and useful, and certainly not able to be the building pillar of the virtual monetary system, because the trust is still within Facebook’s existing business and couldn’t propagate. To gain trust beyond Facebook’s existing business and even from their competitors, FB Coin must have independent credibility larger than Facebook, which is only possible by using blockchain. FB Coin built on blockchain has three important traits: 1) FB Coin can be transferred to any other system/application/wallet just like Bitcoin, and not confined to Facebook accounts. 2) FB Coin is transparent and independent from Facebook business operation. Even if Facebook bankrupts, FB Coin is there to stay as long as it has enough cash reserve or asset backing. 3) FB Coin as a public ledger can allow any party to join and run a full node on the blockchain. The more parties running the node, the more credible the FB Coin will become. To summarize, FB Coin might borrow some credit from Facebook to speed up the adoption. But in order to build a complete virtual monetary and economy system, FB Coin must be larger than Facebook and blockchain is the only solution that make this possible.
Now we have discussed the business logics of stable coin, as well as who are the issuers and why they want to issue. With the framework in mind, what investment strategy should we adopt as investors? This is an open question and there won’t be any perfect answers. But as of now, a few key thoughts are:
1) Be able to recognize scams and avoid.
2) Stable coin projects without support from core business like exchanges, are less attractive. For stable coin that is supported by exchanges, top players are better bets due to winner-takes-all effect.
3) For companies like Facebook and JP Morgan, if their stable coin initiatives succeed, the value will be captured by the company, which will benefit the shareholders. So we can long relevant stocks form the secondary market.
The blockchain industry is changing too fast. Whatever is discussed in this article might be outdated in the near future. We will review and update this article periodically.
