Real Stablecoins

By Jordan Bruce MacLeod

January 30, 2019

Background

The global monetary system has been operating without a hard anchor since Richard Nixon closed the gold window in 1971 and began formally floating the dollar’s exchange rate in 1973. Until this point, the US had always been anchored to gold, silver or both since the country’s founding.

As the acting global reserve currency since the Bretton Woods agreement, the removal of the hard anchor from the dollar led to a floating exchange rate system between nations. Over time, this new monetary system began weakening monetary and fiscal discipline. Trade imbalances persisted, as did the Triffin Dilemma (with new dynamics), whereby the United States was forced to hold balance of payments deficits, which often brought conflicts between their international currency obligations and domestic monetary policy.

Today, this system is reaching the limits of its capacity to function effectively. Calls to replace the dollar as the global reserve currency have grown louder and more persistent. An increasing number of American economists have pointed out the dollar’s role as global reserve currency has become more costly than its benefits.[1] Other economists have observed that floating rates have introduced volatility and unpredictability to exchange rates, which has been harmful for trade.

Given these dynamics, monetary economist Warren Coats concludes, “monetary policy is being asked to deliver more than it is capable of delivering. Central banks are generally staffed by very capable people, but they can never know all that they need to know to keep the economy at full employment as employers and jobs keep changing… The idea that central banks can micro-manage monetary conditions to smooth business cycles is a conceit. In my opinion, central banks have given their price stability mandates their best shot and failed. The successful, countercyclical management of the money supply with floating exchange rates is simply beyond the capacity of mortals.”

As a consequence of these conditions, several economists and central bankers — most notably China’s Zhou Xiaochuan — have called for a new global reserve currency and hard anchor to stabilize international trade: “the acceptance of credit-based national currencies as major international reserve currencies, as is the case in the current system, is a rare special case in history. The crisis again calls for creative reform of the existing international monetary system towards an international reserve currency with a stable value, rule-based issuance and manageable supply, so as to achieve the objective of safeguarding global economic and financial stability.”[2]

While Triffin predicted the necessity to carry fiscal deficits could ultimately bring the United States’ capacity to honor its growing debt obligations into question, it is also becoming increasingly clear that deteriorating domestic fiscal conditions also create major disincentives, if not incapacity, to end the dollar’s global reserve currency role. For this reason, there remains a virtual absence of political will to create a monetary system with a new global reserve currency that is truly fit for purpose.

Given the limitations of inflation targeting by central banks, such a reserve currency should be designed to optimize conditions for global trade and eliminate dependency on imperfect information and forecasting. To achieve these ends, it should have several essential properties, including a hard anchor to the real economy via a commodity basket or index, and follow currency board rules.

Decentralized Currency Boards

Decentralized Currency Boards (DCBs) is a term used by the author to describe the emergence of blockchain-based stablecoins that are anchored to a relatively stable value (most often the dollar) and backed by cryptocurrency or cryptoassets as collateral. Dan Larimer’s BitShares was the first DCB in 2014 and other projects have emerged on the scene since. DCBs typically utilize volatile cryptocurrencies to collateralize stablecoins and have built-in smart contracts to address collateralization requirements, liquidation terms and management, asset issuance, redemption and other typical currency board functions.

Decentralized Currency Boards are a part of the rapidly growing stablecoin asset class within the $150 Billion cryptocurrency ecosystem. Designed to hold medium to long-term value rather than function as a speculative asset, leading stablecoins are typically tied to the US dollar, holding more than $2.5B USD in value. This number is projected to increase exponentially as the ecosystem matures and traditional assets such as equities, bonds and real estate are tokenized.

It is well understood by economists and savvy-business leaders that the global economy cannot rely on highly volatile currencies for trade and lending. And while leading crytpocurrencies such as Bitcoin and Ethereum are exceptionally volatile, we have also seen that even the US dollar is becoming problematic functioning as a global reserve currency.

Creating cryptocurrencies with a hard anchor and indirect redeemability makes it possible to deploy stablecoins with more predictable purchasing power, optimized for global trade and commerce.

Truly decentralized stablecoins (i.e. real stablecoins) anchored to the real-world are capable of serving an immediate purpose in the global economy — especially in the absence of a true global reserve currency. In fact, they are capable of serving a number of different interest groups and sectors with a number of different indexes that appropriately address their needs by linking to a variety of inflation-tracking indexes and commodity baskets based on their particular industries, risk exposure and use cases.

Similar hard anchor systems have been advocated by many of the world’s leading monetary economists since the Great Depression as a means to create a global currency that is superior to a gold standard, immune to inflation, pro-cyclical effects, changes in velocity and demand, as well as miscalculations by central bankers. DCB-created stablecoins may not have the capacity to function in a global role, but they can satisfy real demand for purchasing power protection in global trade.

Within an open source ecosystem, DCBs can apply the same, proven currency board rules within a decentralized environment predicated on free-market principles, voluntary agreements and consensus-based systems. This setup allows for a market-driven, decentralized approach to real stablecoins that will evolve over time to increasingly reflect changes in global purchasing power with more precision and accuracy.

One World Currency?

The growth of DCBs may also begin to produce network effects around particularly useful and popular indices and units of account that in turn naturally inform the optimal hard anchor for the next global reserve currency. With the potential mainstream adoption of blockchain tokens to represent real-estate, national currencies, equities, bonds and other asset classes, these cryptoassets could then serve as the underlying collateral for real stablecoins. As network effects take hold, we may also find that the next global currency is not money as we know it but rather simply a unit of account that anchors constant global purchasing power over time. This unit of account could then be issued by DCBs and centralized institutions using currency board rules; backed by a near limitless choice in asset classes.

Bibliography

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Available at: https://works.bepress.com/warren_coats/38/

____________, Dongsheng Di and Yuxuan Zhao. “Why the World needs a Reserve Asset with a Hard Anchor” Frontiers of Economics in China (2017)
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Steve Hanke, “In Emerging Markets, It’s Time To Dump Most Central Banks, And Their Currencies Too.” Forbes, March 22, 2017.

MacLeod, Jordan Bruce, New Currency: How Money Changes The World As We Know It, Integral Publishers, 2009.

Xiaochuan, Zhou, “Reform the International Monetary System”, Website of the People’s Bank of China, March 23, 2009.

[1] Bernstein, Jared, “Dethrone ‘King Dollar’”. The New York Times, August 27, 2014.

[2] Xiaochuan, Zhou, “Reform the International Monetary System”, Website of the People’s Bank of China, March 23, 2009.