Crypto Bits — 9 Oct 2019

(UN)Stablecoin

The emergence of the ‘stablecoin’, as we know it, is somewhat of a misnomer — in my opinion. We have hoards of people calling for a new global currency, others seeking fresh liquidity, and some calling for an outright abolishment of currency, namely fiat, as we know it.

And yet, somehow in the process, as cryptocurrencies have matured we’ve ended up embracing fiat-type, government-backed coins. The most widely used stablecoin is essentially an IOU — a 1:1 digital currency that is a digital replica, in value at least, of 1 USD / EUR / GBP. Makes sense, right? Real-world collateral offers us the comfort of stability in such a volatile market.

But…how stable can a stablecoin truly be if it trades at different prices on different venues? Fragmented markets and regulatory disparities throughout regions naturally give rise to these types of phenomena, and the evolving market structure also bears risks. Despite the rise of algorithms and more sophisticated mechanisms of price discovery, flash crashes are still prevalent across a slew of traditional markets. Liquidity providers pull their orders from lit venues upon the first sign of stress or shock to the system, and within crypto, stablecoins are arguably the group most prone to jump-to-default type risks.

Perhaps more importantly, how does a fiat-backed stablecoin resolve issues of hyperinflation or poor fiscal discipline in an age where the major central banks turn to currency debasement at the first sign of soft economic numbers. Arguably one of Bitcoin’s most attractive properties is its hard-capped supply — the perfect theoretical antidote to a world of endless monetarism.

We’ve come to trust a centralised digital coin subject to the same geopolitical, counterparty risks, and high transaction fees as the exact system that backs it. How truly stable will such a stablecoin really be?!

True to form, the first controversy to taint the stablecoin world was none other than USDT/Tether and its under-collateralisation. When dealing with stablecoins such as USDT, True USD and Digix we are functioning on the basis of trust — trust that the issuer is collateralising the coin as promised and performing audits on said indemnity. All of which is due to a lack of transparency, the very issue the crypto space seeks to eliminate.

In the case of Tether, the firm refused numerous calls for audits. Tether, of course, claims that it is backed 100% by USD but limited evidence or balances have been provided to support such claims. From the ashes of the Tether controversy, True USD was born — performing routine audits and publishing its balances. Still, neither coin is truly trustless and both are plagued by all the risks bred by centralization (human corruption, regulatory etc…).

Digix, on the other hand, is backed by Gold: one DGX = 1 gram of gold. If you’ve read my previous ‘Crypto Bit’ on recent controversies surrounding gold you may agree that this is neither safe nor secure — or you may disagree as gold is traditionally regarded as the safe investment we’re all familiar with.

So we have essentially witnessed the launch of an arguably illiquid coin due to its backing by the very currencies we sought to escape… right?

Stablecoins are not limited to the aforementioned centralised fiat-backed coins — we have two other categories that may or may not provide better solutions. Crypto-collateralised onchain stablecoins (cryptocurrencies locked into smart contracts) and algorithmic stablecoins are both alternatives to fiat-backed coins. Their pros and cons are a discussion for a later date.

That said, there’s no denying the “value” such coins bring to the cryptocurrency markets, mostly in the form of adoption. Most crypto-only exchanges depend on Tether as an on/off-ramp. At the time of writing, Tether is ranked fifth by market cap at over 4.1 billion USD. Most pairs on exchanges are against BTC, ETH and/or USDT, which has cemented Tether’s position in the crypto markets — vulnerabilities aside.

In the same way that governments have ingrained themselves in our day to day spending, transacting and saving, stablecoins backed by the very same currencies we are supposedly trying to avoid are doing the same thing. The ease of use of a stablecoin like Tether is undeniable, even when faced with looming concerns around the firm behind it.

The same can be said for emerging global digital currencies like Facebook’s Libra — when faced with the ease of transacting across borders via one easy platform such as WhatsApp (hypothetically), many will ignore the complete trust they’re placing upon a single firm, entity or government. Take WeChat Pay for example which at one point weakened the PBOC’s full control over the Chinese money supply, empowering Tencent instead.

If we can infer anything from public behaviour in this space, we can most definitely presume that we are creatures of habit drawn to convenience despite any red flags looming.

So while stablecoins offer investors a sense of security and familiarity — as an investor I believe my stablecoin is minted on an exchange for fiat and can, in turn, be redeemed for fiat, much like a demand note or swap — how many of us have successfully tried to redeem the IOUs in our pocket?

In fact, Stablecoins pegged to rapidly inflating fiat currencies are anything but stable. What we really need is a digital coin whose valuation is based on more than a wing and a prayer; a coin with a limited and fixed supply rather than minted at will…oh wait…

So, let me wrap up with the words of Wu Tang — Cash Rules Everything Around Me, albeit centralised and uncollateralised for now.

Diana Pires — Head of OTC Sales, B2C2

What regulation really matters?

The old adage “there’s no such thing as a triple bottom” certainly rang true for Bitcoin in late September. On the third tap of 9200, we broke with volume which precipitated a cascade of liquidations. Within just a few hours a meaningful slab of leveraged length had been purged from the market. The overarching technical setup doesn’t look so hot right now but I was pleased to see leveraged length set above 10k largely decimated. I am still a structural bull and think the broader market is underestimating the flow impact of the upcoming halving. That said, for those engaged in USD denominated trading strategies I’d consider some hedges or tactical shorts back up in the 8700–9000 zone.

The BitMEX insurance fund now holds just shy of 0.15% of all the BTC the market expects to ever come into existence (21 million assuming no changes to the BTC protocol). If you give credence to Chainalysis’ claim that around 3.8 million coins are forever lost, the insurance fund’s share of the effective terminal supply is closer to 0.18%.

Lots of chatter this past week about the SEC’s ruling on Block.one’s EOS token sale. After the initial clamour of disapproval across social media subsided (24 million is a paltry fine in the context of a 4 billion raise), some commentators framed the SEC’s seemingly lenient stance as a net positive for the broader crypto industry. Others suggested the ruling demonstrated how the SEC is open and willing to work with new projects as the landscape for raising capital continues to evolve. After all, the hammer seemed to come down much harder on projects that eschewed working with the regulators. Well, no surprises there.

As someone who views Bitcoin’s provably fair PoW launch as a critical ingredient in its long term success, I am less concerned with the regulatory developments in the arena of security issuance. Although interesting, areas such as the tokenization of securities, token offerings, private blockchains, centrally managed stablecoins, or even non-fungible tokens run largely orthogonal to the main intellectual thrust of Bitcoin — the idea that open-source software whose core feature is a preset disinflationary supply schedule can bootstrap to one day function as a global money. Whether that vision can even be achieved is of course not a foregone conclusion, but what does seem clear to me, is that any protocol that sets out to be a global medium of exchange whose distribution is perceived to favour special interest groups is set to fail on ideological grounds.

A moment of silence for the ZEC bagholders as they continue to absorb supply from the ‘founder’s reward’, where a staggering 20% of newly minted coins continue to go to “founders, investors, employees, and advisors”.

In the future, and with the blessing of the community and implicit market endorsement notwithstanding, it may be trivial to incorporate optional privacy into Bitcoin transactions. It will be impossible, however, to wind back the clock and repair an inherently asymmetric distribution. Ideology over technology, every time.

But although I feel fairly comfortable in my assessment that semantics around what does or does not constitute a ‘security’ in the alt-sphere won’t prove relevant to Bitcoin’s long term success, that doesn’t mean I think the outlook is devoid of regulatory risk.

Earlier I alluded to the size of the BitMEX insurance fund as it feels like a sign of things to come. In truth, its magnitude is a testament to their success. They succeeded in providing an innovative product suite, replete with an easy to use platform/API and a flawless track record in wallet security. They are of course not the only success story. More generally, exchanges that have excelled in transparency and security have been rewarded with strong volumes.

A more curious characteristic of some of the most successful venues is that they eschew the traditional banking system entirely. Crypto in, crypto out. So, how do regulators feel about highly successful businesses with upstanding reputations and no real grievances from their customer bases that operate outside the purview of international watchdogs? It’s a good question.

Here’s the guidance from FinCEN (responsible for AML in the US) published in May this year. They are the key ‘financial intelligence unit’ (FIU) within the Egmont Group — a collective of 164 FIUs from different countries around the world, that together seek to combat money laundering. Well, the guidance is dense but clearly stipulates it relates to ‘money services businesses’. The tricky thing is, these sort of definitions may be clear within one jurisdiction or another, but they are far from obvious when you sail into the murky domain of cryptocurrencies.

As the prominence of Bitcoin grows, I suspect key players will become increasingly more involved with regulators in the global fight against money laundering, but the reel of headlines may spook the market. Transparent public blockchains are in theory the worst avenue for insidious actors to use, but the public still doesn’t appreciate this.

For the ETH lovers, DevCon5 kicked off in Osaka yesterday and will run until the end of this week (8th-11th October). I’ll leave the more technical details to commentators better versed in computer science, but my understanding is that we are due to see one of the first demonstrations on the viability of ‘ETH 2.0’ or ‘sharding’. Sounds like they are finally making progress on scaling the protocol, and given ETH is the most decentralized smart contract protocol, I’m open to being a longer-term bull.

What’s interesting from a trading perspective, is that the premium in ETH gamma (which you’d expect) has been hard to marry with the occasional negative funding set in the ETHUSD perpetual swaps. My guess is that the recent technical damage to BTC has impacted sentiment, and panic hedging has been digested of late. I think the risk is skewed higher for ETHBTC, especially given other altcoin majors (eg. XRP) are trading well and appear to have found a base in their BTC pairings. Lastly, although I find BTC dominance to be a dubious statistic, it is something many traders in the space keep tabs on when looking for altcoin setups, so as it slips further below 70% it should support sentiment. For those with an eye for fundamentally sound low-caps, it’s a great time to go gem hunting on the more obscure exchanges. There’s a ton of interesting projects out there, just remember to keep the fairness of distribution and degree of decentralization in mind, as both are pivotal in a project’s longer-term success! Good luck.

Scott Weatherill — Chief Risk Manager, B2C2 Japan