No More Tokens: Fiat-backed stablecoin as ideal crypto collateral
These CEXs claim they have enough reserves, but the value of their tokens could drop as quickly as FTT and cause the bottom to fall out. If there’s any certainty about today’s crypto, sadly, it’s uncertainty.
In the weeks since the collapse of Sam Bankman-Fried’s $36 billion crypto exchange FTX, we have learned a great deal. As one after another platform has stumbled in its wake — Bitfront and BlockFi, Genesis and Voyager Digital — we now know that fears of contagion are to be taken seriously. We also know that the actions of even those who claim to be idealists, like SBF and his effective altruism, should be questioned just as much as those of anybody else. Perhaps most importantly, we now know beyond a shadow of a doubt that using exchange-issued tokens as collateral is deeply problematic — though this last lesson may point to the industry’s future.
Token collateral is essentially what brought down FTX. As has been widely reported, its crypto trading fund, Alameda Research, had for some time been borrowing the funds of FTX depositors and using FTX’s native token, FTT, as collateral on those loans. This balancing act worked as long as FTT maintained its value — which it did, thanks to FTX and Alameda’s manipulations. But when investor jitters drove FTT down 75 percent in a single day, suddenly Alameda had insufficient collateral to cover its trades and the house of cards collapsed, leaving as many as a million creditors out in the cold.
The question to ask now is whether any other crypto exchanges have been propping themselves up with user funds and leaning too heavily on tokens as collateral. Many analysts fear there’s more to come. “The FTX collapse could be the start of a wave of cryptocurrency exchange failures,” Duke University economics professor Connel Fullenkap wrote in the New York Times. “It’s pretty likely that other firms are doing what FTX did with its customers’ money, and that some of them will blow up in the same way.”
Today we have a better grasp of exchanges’ assets than we did six weeks ago because the trend is toward transparency, thanks in part to Binance CEO Changpeng Zhao, who shortly after FTX’s collapse publicly urged all exchanges to perform a proof-of-reserve (PoR). What’s proof-of-reserve? “In simple terms,” writes industry outlet BeInCrypto, “proof-of-reserve is a process by which an exchange verifies that it has sufficient reserves (in this case, fiat and cryptocurrency) to back its customers’ balances.” The review is generally done by a third-party auditor, creating a snapshot of the company’s on-chain assets to provide proof of adequate liquidity, or the lack thereof.
One reason CZ, as Zhao is known, may have advocated PoR is that Binance performed quite well on its self-audit, with a 101 percent reserve ratio. Yet of Binance’s nearly $75 billion in crypto holdings, about nine percent is in BNB, its native token. This is a relatively small portion: if BNB were to tumble, could it cause the industry’s top exchange to wobble? Binance is probably safe, but it’s worth noting that, as of mid-December, BNB had fallen more than 20 percent from its November peak.
Crypto.com may be in greater danger. In November its CEO said the firm has always had 1:1 reserves and never used its native Cronos token as collateral. Crypto.com also released its PoR, showing nearly a third of its reserves in Bitcoin. But many expressed concerns about Crypto.com’s second-largest reserve holding: 20 percent in speculative meme token Shiba Inu. Crypto.com has said this is only part of its holdings and that it would soon release the full PoR, but as of early December it had not yet done so. Since its September 2021 peak, SHIB has lost about 90 percent of its value.
As more and more exchanges go in for PoR, observers are increasingly questioning its utility. One reason is that it only gauges reserves without considering liabilities. “This is either ignorance or intentional misrepresentation,” Jesse Powell, the CEO of Kraken Exchange, said on Twitter. “The statement of assets is pointless without liabilities.” Another issue is that PoR is merely a moment in time — it cannot give the origin of any of the reserves, nor determine how long they have been on the books. An exchange could simply add reserve funds just prior to a PoR and give them up soon after. Finally, a PoR audit provides no detail or ratings on the quality of the asset. In Crypto.com’s PoR, Shiba Inu, for example, is presented as just as reliable as Bitcoin.
Several smaller exchanges seem to still rely on native tokens as collateral. In its PoR, Bitfinex revealed that more than a third of its $7.6 billion in reserves (35%) are in its own LEO token. According to the data on Nansen, 18 percent of Kucoin’s reserves are in its KCS token, while Huobi has almost 30% of its reserves in its native HT. These CEXs claim they have enough reserves, but the value of their tokens could drop as quickly as FTT and cause the bottom to fall out. If there’s any certainty about today’s crypto, sadly, it’s uncertainty.
The best way to ensure stability for these exchanges, and perhaps all crypto platforms, is to eliminate collateral that relies on tokens or algorithmic stablecoins. Only fiat currency, fiat-backed stablecoins and established cryptocurrencies like Bitcoin and Ethereum should be used as collateral, as in the case of MakerDAO’s DAI stablecoin. Despite using BNB as a small slice of its collateral, Binance might provide a decent model. Nearly a third of Binance’s assets — $23B out of $74.6B — is in its stablecoin BUSD. The crucial element with BUSD is that while Binance provides the branding, Paxos Trust is the actual issuer. Not only is Paxos regulated by the New York Department of Financial Services (NYDFS), but in July it revealed the assets behind BUSD, which included billions of dollars worth of US Treasury bills and bonds and hundreds of millions of dollars in cash deposits.
This is precisely the type of transparency needed to calm today’s deeply unstable crypto landscape. Like BUSD, GMO Trust’s ZUSD stablecoin is also regulated by the NYDFS and backed by fiat currency reserves. It’s similarly stable, and highly diversified, being part of the conglomerate GMO Internet Group. Unlike BUSD, it’s not linked to a parent that continues to rely on native token collateral. Instead, as part of a Japan-based conglomerate, ZUSD’s assets are largely disconnected from the contagion that has undermined the industry in 2022. Of course, Asia has not been immune to the crypto shakeup. Bitfront, an exchange launched by the Japanese chat app Line, shut down several weeks ago after failing to adequately adapt to industry turmoil. And Hong Kong-based exchange AAX halted withdrawals in November, just before its top executives disappeared.
But such incidents have been much more infrequent in Asia than in the US, which is why ZUSD is perfectly positioned to serve as stablecoin collateral for exchanges looking to move away from a problematic reliance on native tokens. This is one reason ZUSD, in November, launched on the Stellar blockchain network, as GMO Trust offered no-cost swaps between the Ethereum and Stellar versions of ZUSD and its yen-backed stablecoin GYEN.
・Learn more about ZUSD and GYEN at https://stablecoin.z.com/
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