Bitcoin and Tether have the largest daily trading volume of all crypto-currencies. I would like to suggest they are also our greatest teachers but not in the way you may at first expect.
Consider that Bitcoin may have reminded us that people create money. Not governments or central banks. People. At its launch in 2009 there was no legislation, no central bank involvement, indeed none of the usual trappings of government at all. Just a few geeks. Ten years later the pieces of cryptographic code that are Bitcoins are (again) trading above $5,000.
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People did that. People are also waking up to the fact that the way the Federal Reserve increases the money supply is not the process that gives money its value. In revolutionary France, the government ordered on pain of death that people use assignats, the legal tender of the day. People flatly refused. That is to say, the power to create money does not rest with the Federal Reserve. The money it creates to fund government debt only has value because people accept it has value. People like you and me do this. As we start to wake up to this ability how will the financial system start to look?
So maybe Bitcoin has taught us is that people create money. But what about Tether?
Tether had a bad year, reputation-wise, in 2018. The claims that the coins are not backed one to one with US dollars continues today. On top of that, it lost its banking relationship so that for a while it was unable to make redemptions and give people back their dollars in exchange for the coins.
Now, this is a big deal because the mechanism by which parity between Tether coins and the US dollar is maintained is through the control of supply. It is the same mechanism that kept currencies linked to gold during the gold standard era. It is used by currency boards such as the Hong Kong dollar to keep its peg to the US dollar. ETF’s use the same mechanism to keep their shares at par with the underlying asset. This is how it is supposed to work:
If Tether coins fall in value so that a coin’s traded value is, for example, 98 US cents then people will bring their coins to Tether to convert to US dollars at the official price of 1 coin = 1 US dollar. In doing so they profit 2 cents for each coin they redeem.
Tether takes the coins it receives and removes them from circulation. Supply is reduced. The process continues until the value of Tether is again at the 1:1 parity with the US dollar.
On the other hand, if Tether is trading at $1.02 a coin then the reverse happens. People use their dollars to buy coins from the Tether organisation at the official price of 1 coin = $1. In doing so they make 2 cents profit on each coin they buy because the coins are trading at $1.02. The coins Tether issues are new so they increase the total supply of coins in circulation. This continues until the increase in the number of coins brings their value back to the 1 coin = $1 parity.
This active management of supply to maintain a peg is simple and it works. The discipline it imposed on central banks controlling the amount of base money they issued is what we lost when the US left the gold standard in 1971. However, last year Tether had no bank and so could not make redemptions. Did its peg with the US dollar crash? No. So if it was not the active management of supply that was maintaining Tether’s parity with the US dollar what was?
Not only are people the sole creators of monetary value, but they are also capable of maintaining a peg. Last year, before the influx of new stablecoins, Tether played an essential role in the crypto-currency eco-system for new entrants and traders between trades. This need for stability, combined with the expectation of stability is likely to be the reason Tether’s parity remained.
The Tether example is not an isolated experience. Gold, itself the basis of money for the last 4 thousand years has been of stable value precisely because people have needed a stable means of exchange. Tether may be reminding us that we are capable of maintaining a peg even in the absence of active mechanisms controlling supply.
Why are these two lessons — that people create value and can maintain a peg — important? These two human talents enable the creation of new financial products outside of the risks of the fiat financial system. They enable finance that is robust like the Internet where if one component fails the whole system is not at risk. Bitcoin is one such product. Saver Token is another. Once these building blocks are fully grasped we may witness a whole new financial eco-system developing — a system driven by the innate talent of people like you and me.