Icewater is a project dedicated toward building a non-pegged stablecoin, called H2O. Why do we need something like that?
In a word, decentralization.
TLDR: Icewater is the only truly decentralized stablecoin.
Before I explain anymore, I want to point out a few questions this article is not meant to address:
- why do we need crypto?
- why do we need decentralized finance?
- why do we need a stablecoin?
- is the US Federal Reserve going to cause massive inflation of the dollar?
So let’s get started with…
Pegging to the US Dollar is not Decentralized
Most stablecoins define stability based off some fiat currency, usually the US dollar. Examples of this kind of stablecoin include DAI, USDT, UST, USDC…pretty much all of the most common coins.
These stablecoins are not bad. We just need to realize that their value (all of them) is ultimately controlled by a single centralized institution: the United States Federal Reserve. If the Fed decides to inflate the dollar, all of these coins will go with it.
You may or may not trust the Fed to prevent inflation. as I pointed out above, I’m not going to argue about that here. I just want to point out that regardless of whether you trust the Fed, you should concede that it is not a decentralized institution. Therefore, if you care about decentralization, you should be looking for alternatives.
Other Ways to Achieve Stability
So if you want to define stability based on something other than the dollar, there are basically two ways to do it: you can rely on experts, or you can rely on markets.
Inflation is a very leaky concept because what does it even mean for the value of a currency to remain stable when the values and prices of everything else are changing.
Well, the experts at the United States Bureau of Labor Statistics have some very sophisticated models for figuring it out. But guess what? The BLS and their products, like the consumer price index (CPI) are also centralized!
In fact, I would argue that they only way to achieve a decentralized stable is to establish some kind of market mechanism for determining stability.
Market Mechanisms for Defining Stability
OK, so if you need a stablecoin, and you want it to be decentralized, you need a market (preferably an automated market) for defining stability.
In a somewhat famous post about stablecoins, Vitalik divided market mechanisms into two categories: exogenous and endogenous. An exogenous stability measurement defines stability based on something outside the system (say, the price of a loaf of bread) and endogenous systems define stability based on something internal to the system.
Vitalik pointed out a few problems with a particularly interesting system for measuring an exogenous price, called shellingcoin. But I would make the more general point that any system that defines stability based on something outside the system is going to rely on some kind of oracle. Basically, an oracle is just some mechanism for finding information about outside variables.
Most people I talk to about decentralized stablecoins have some idea about pegging the price of the coin to some other commodity, like bread, water, electricity, etc. However, all of these solutions are subject to what is called “the oracle problem.” Here is a discussion of the oracle problem from a well known team that makes it their business to solve this problem.
However, relying on an external oracle has two main problems: 1) defining stability is still complicated and messy, and 2) you can’t really ever trust the oracle.
Market Stability without an External Oracle
So now we come to the fundamental challenge of the Icewater project. How do you define the stability of a currency without relying on anything external?
Going back to Vitalik for a moment, he proposed several possibilities for things that can potentially be measured internally: Computation costs, Transaction fees, Data storage costs, Bandwidth costs. All of these basically relate to the cost of running a network. For example, computation costs can be measured by setting some computationally complex problem and then seeing how much you have to pay people to solve it.
All of these costs are bad measures of stability because there is no inherent reason to think that computer technology is going to remain stable.
Luckily, Vitalik missed a really important way to measure stability that has nothing to do with computation costs: a futures market.
The fundamental insight is that true stability does not mean that something has an equal price to some external commodity. It means that the value is stable over time. And what does that mean? We just let the market decide.
In a nutshell, we just offer people some currency in the future and see how much they will pay for it. If people are willing to pay 1 coin now for 1 coin in the future, that means they predict that price of the coin is going to be stable!
By relying on an internally driven market to determine the future price of money, the Icewater protocol is able to define stability in a way that is decentralized and elegant (i.e., it doesn’t rely on a messy oracle to decide what inflation is, and what it even means).
If you believe in a decentralized future for decentralized finance, you should be seeking an alternative to pegged stablecoins. The Icewater project is only protocol to do this without relying on a complicated external oracle.