The Stablecoin you Decide to Spend will Determine how Future Banking Unfolds
Stablecoin is a type of a cryptocurrency that is designed to be ‘stable’ by minimizing the volatility of its price, unlike other speculative cryptocurrencies like bitcoin. This is important, as people will not like to spend (risk of appreciation) and receive (risk of depreciation) currency that keeps fluctuating in value.
However, for those outside of the blockchain world, the question of why Stablecoin even matters when stable USD exists makes sense (although it does for those who live in places with currency that’s more volatile than bitcoin). It may seem irrational that Facebook has cherry-picked their top executives and engineers to lead a Stablecoin project, while raising $1B of outside funding, when they have many other issues to solve.
Facebook is showing that this project is one of their top priorities by developing their Stablecoin initiative, GlobalCoin, at a rapid rate. Their white paper will be released on June 18th, while GlobalCoin is set to launch in the first quarter of 2020.
Hence, it’s important to understand why cryptocurrency that is stable matters for us as users and why it matters for large organizations like Facebook and J.P. Morgan, along with 122 other Stablecoin projects that are also funded by some top-tier investors including Andreessen Horowitz, Founders’ fund, Goldman Sachs, Reid Hoffman (LinkedIn founder), Jack Dorsey (Twitter co-founder) and many other crypto funds. Just in top 15 Stablecoin projects this year, over $1.743B was raised to fund these initiatives.
Stablecoin will be part of our future, but we must understand what using them implies in the long run. Whoever wins the race towards being the dominant player will have massive implications in how our society evolves, so I hope to introduce why they matter and what we should look out for.
Firstly, currency being on the blockchain means that you can avoid paying all the middlemen that took a huge fee for settling payments and remittances, while speeding up money transfer. These problems existed because moving money required high degree of trust, which blockchain technology abstracts for us.
This is so significant that Accenture published a report claiming that blockchain technology could reduce infrastructure costs for eight of the world’s ten largest investment banks by an average of 30%, which translates to $8B to $12B in 2017.
Furthermore, the results of a recent study (March ’19) showed that blockchain remittance transfers are on average 388x faster and 127x cheaper than traditional remittance channels. For more about this industry, which will be a trillion USD market by 2022, and how blockchain solves remittance, I recommend a read of their published report.
Despite these benefits, cryptocurrency’s volatility made its usage unappealing for businesses and users, which is why many still have not adopted using cryptocurrency for remittances. However, Stablecoin removes this pain point by eliminating the risk of appreciation and depreciation, so that cryptocurrency can be used for mainstream purposes like the way we do with credit cards.
Secondly, trust issue can be eliminated. In Korea, there’s a saying that “once you lend money, you lose a friend,” as without a formal contract, there’s a high chance that you may never get your money back. Even if you had one, taking things to court requires one to pay for the legal services.
According to a survey of nearly 3,000 adults by CouponCodesPro,
“About two-thirds of people who lend money never see it again.”
That problem is eliminated via smart contracts, where codes hold certain conditions so that transactions occur when those conditions are met. For example, if there’s a condition that says the next 10 coins my friend gets in his Stablecoin account will come to me, then there’s no way for him to stop those 10 coins from leaving his wallet once that condition is met. No friends lost and no need to hire an enforcer if the sum gets large!
This also applies to our trust with banks and governments, which have the power to do what they want with our economy, especially within the fiat currency system that is not pegged to a scarce or fixed resource like gold. There is no need for transparency in how decisions are made and no way to ensure that economic growth is distributed fairly. Central banks have control over credit supply, liquidity, interest rates and money velocity and if they make poor decisions, like they did in 2009, we suffer the consequences.
As fiat (which in Latin, means ‘let it be done’) currency is technically backed by nothing, it is fair to say that our currency is completely based on faith that you can exchange your money with goods and services.
Why do we live in a world where the power belongs to a few? It’s because the Federal Reserve System was made by a few. One of the founding members, Frank Vanderlip, the president of National City Bank of New York, said,
“I was as secretive — indeed, as furtive — as any conspirator. Discovery, we knew, simply must not happen, or else all our time and effort would be wasted. If it were to be exposed that our particular group had got together and written a banking bill, that bill would have no chance whatever of passage by Congress.”
But if it is driven by smart contracts, then we can add more consistency in how decisions are made and prevent a centralized entity from suddenly printing a lot of free money, which causes rapid inflations.
Moreover, if the Stablecoin takes Proof-of-Stake consensus algorithm, where the amount of governance you have is proportional to the amount you stake, then one can no longer solely work for their own interest, as they will be slashed for making decisions unfavorable to the community. Those who govern in this system profit by voting and adding blocks to the blockchain. Hence, as long as they don’t get slashed, they will maintain profitability.
This ensures that those who govern the Stablecoin works for the community’s best interest. You could also help the best governors have a greater voice by contributing your own money to their stake. In return, you get to share the profit when the governor you decided to stake on (also known as the validator) profits.
With these benefits in mind, it’s important to ask why so many companies want to be the first mover and why Facebook is moving so fast to get there. Facebook has their own specific reasons of why (written by yours truly), but there are also very compelling business reasons why many investors are betting on multiple Stablecoin projects.
While the details are explained well by one of the partners of NGC ventures, the main reason why is that Stablecoin creates its own value and economy when more people use that Stablecoin.
To better understand what this means, we can explore how Stablecoins make profit. The two main sources of profit are a low cut from each transaction (like taxes) and seigniorage, which is the profit made when more supply of a currency is issued and there’s a positive difference between the face value of a coin and its production cost.
In the case of a Stablecoin, the production cost of issuing money will be 0 since all cash is virtual. However, what matters here is the money multiplier, which in highly simplified terms, means that for every unit of Stablecoin you mint, 5 units of that Stablecoin will be created and circulating in the Stablecoins’ ecosystem (for more details, reference here).
This creates an opportunity for a business to suddenly accrue a huge amount of value if people actively spend their money using these Stablecoins. In 2000, US government earned about $25B annually in seigniorage, which brings us to the important question of which ecosystem do we want to see succeed?
This question has become more relevant as Tether, the Stablecoin with the largest market share, has shown that it could lie about their claims that it’s 100% pegged to USD and have people not be able to do anything about it. As shown by Tether, it’s easy for cryptocurrency to be centralized and not necessarily function as a decentralized platform, which makes the process of evaluating each Stablecoin even more important.
What’s interesting is that some white papers don’t even mention the term seigniorage. In the case of Circle’s USDC Stablecoin, they do mention how they will respond to situations where seigniorage may arise, claiming that “if the value of a token surpasses the prefunded fiat buffer maintained by the Circle,” then the tokens will be “placed in reserve to service future requests or else burned/destroyed.”
However, there’s no specific detail on how this reserve will be used. How could we hold the Stablecoins accountable that they will use the profit made to benefit the community if they don’t specify how the profit made from the seigniorage will be used?
A team that did show how their treasury was going to be used was Terra, which is working to create a stable DApp (decentralized application) platform from the seigniorage they earn. By having the validators of Terra choose which DApps will be funded and how much the they will be funded according to the equation below, they can objectively select those that have robust economic activity and efficient use of funding.
This ensures that the DApps that best serve the interest of the Terra community are funded (remember all the money some ICOs ran away with?), while maintaining transparency and preventing a centralized power from making questionable decisions that could create an unfair advantage. Seigniorage works because Terra’s goal is to replace fiat collateral with their staking token.
The question then becomes why can’t we see these benefits in today’s economy? That’s because the government spending is chosen by a committee with their goals in mind, which is also influenced by the lobbyists.
Hence, an economy which prioritizes rewarding those who contribute to its growth and stability is bound to potentially be superior than that of today.
On top of seigniorage, Terra uses algorithms to maintain its best price by pegging to world’s major currencies instead of relying solely on one and having validators vote for best exchange rate. If validators do not vote for the best price (within 1 standard deviation of elected median), then they will again be slashed.
By addressing many of the key trust issues via algorithms and holding major stakeholders accountable, Terra becomes a functional decentralized platform that rewards those who work to make it better.
This means that for those in countries with volatile currency, it will be better for them to hold their money with Terra than to keep it with their local currency, as the protocol supports atomic swaps at the appropriate fiat exchange rate for the currencies within its family.
For example, if a cup of coffee was worth 5 coins and there is a severe inflation, then I may need 10 coins to buy the same coffee. But if I held the local coins on Terra instead, then I will know that the validators will adjust the exchange rates so that I can still get the coffee without having to pay twice the price.
For more about Terra, which had their Mainnet launch 2 months ago, I highly recommend their white paper.
As Terra has shown us, where we choose to spend our money next could strongly influence how our future unfolds. Economics has interesting dynamics where active transactions translate to creation of value, so if we don’t hold Stablecoin projects accountable for how that new value is used, then the benefits of Stablecoin may funnel into the pockets of a few.
As the former co-founder of Facebook Chris Hughes said, “Facebook’s lock on the market guarantees that users can’t protest by moving to alternative platforms.” Facebook’s sheer size could make it difficult for any competition to happen in the spaces that Facebook enters, which is why it’s important to consider what alternatives there are and see what we should look out for as Facebook develops their new Stablecoin (especially regarding user privacy).
I am optimistic that Stablecoin will bring a lot of good, but the question of how much good will be distributed fairly by each Stablecoin project is one that we need to keep an eye for. With Stablecoins, we will be left with options to choose which currency we would like to use for each transaction.
This gives us the opportunity to drive the future we want and I hope that this empowerment can be met with accountability and healthy discussions from the tech community, so that we can build a future that empowers all.
For more about Facebook’s Project Libra, check out my other hackernoon stories!
Why is Facebook Releasing the White Paper for their ‘Blockchain’ project Libra Now?
Facebook took a route customary for blockchain projects, despite not being a blockchain, because it has realized that timing is now pivotal for Facebook’s plans to succeed.
Why is Facebook developing Stablecoin?
After tumultuous years of dealing with user trust, why is Facebook moving so fast on a project that could potentially erode user trust even more?
