Stablecoins: Revolution vs Evolution
Now It’s Time For Evolution
By Amiya Diwan, Co-Founder at Stably
TL/DR: The revolution of cryptocurrencies has already occurred, and now the mainstream adoption of stable-value cryptocurrencies is most likely to follow a linear path of evolution.
The discussion of revolution vs evolution with respect to innovation is not new. Revolutionary technologies emerge in a non-linear fashion, and they are literal game-changers that make many other businesses possible. An example would be the invention of the internal combustion engine in the late 18th century, which would eventually render horse-drawn carts obsolete and give birth to the automotive industry. Evolutionary technology follows a linear path of iterative and gradual improvement. An example is Toyota’s highly optimized assembly line which drove the global adoption of affordable, reliable and cheap cars.
Revolutionary technology is the gospel of Silicon Valley, with books such as Peter Thiel’s Zero to One and Clayton Christensen’s The Innovator’s Dilemma occupying the entrepreneurial zeitgeist, albeit in a reductive format. However, historical patterns across business, biology, human culture and governance systems indicate that the iterative, linear process of evolution has a higher probability of being successful under a majority of circumstances. Wisdom is being able to classify circumstances as being favourable to either revolutionary or evolutionary approaches. In an article published by the Harvard Business Review in 2011 titled Would You Rather Be Revolutionary or Evolutionary, Jeff Stibel argues:
For the most part, revolutionary ideas are implemented and commercialized by entrepreneurs who make evolutionary advances: the Wright brothers may have invented the airplane, but it was innovations such as airmail, military air forces, and commercial airlines that evolved the invention into a commercial enterprise. The precursor to today’s steam engine — the Greek aeolipile invented in the 1st century by Heron of Alexandria — went nowhere because no evolutionary innovator picked up on it to take it to the next level. Even after the first automobile was developed by Benz, mass adoption took decades. The car would not have revolutionized so many lives if someone hadn’t figured out how to mass-produce cars at an affordable price.
It is straightforward to see how this wisdom can be applied to cryptocurrencies. Bitcoin was a revolutionary application. An emergent property of this was software that allows multiple untrusting parties to come to consensus on a shared database. This is popularly known as blockchain, and allows for the development of open protocols free of censorship and custodianship. However, there is still a long way to go before this technology can unleash its full potential.
The most immediate evolutionary next step is a stable-price medium of exchange
Currently merchants are not accepting cryptocurrencies as a form of payment because of price volatility. This is a shame because public blockchains have the potential to create peer-to-peer payment infrastructures to replace the inefficiencies of SWIFT and ACH. Distributed smart-contract applications built on public blockchains, such as EOS and Ethereum, suffer when they rely on volatile utility tokens as a medium of exchange. The most pressing demand is from cryptocurrency traders who need a native asset to reduce volatility risk, validated by Tether’s massive market-cap.
Much has already been written about the various approaches to creating stable-value cryptocurrencies, or stablecoins, so I won’t go deep into the mechanics. If you want a concise summary, I’d recommend Myles Snider’s article. I have included Snider’s classifications beneath, alongside my own notes of how each of these buckets attempts to leverage or build upon our legacy monetary system.
Fiat-Backed IOU
Referring to the diagram above, “collateral-backed IOU” (which I will rename “fiat-backed IOU”) projects iteratively evolve the state of cryptocurrencies by leveraging and extending the stability of the United States Federal Reserve Bank to the crypto economy. This is because these projects aim to peg their tokens to the USD with a 1:1 fully-backed reserve of cash. Tether was a pioneer with their USDT token, yet their transparency and ability to manage regulatory and counterparty risk have been very publicly called into question. What Tether was attempting to create was noteworthy, and now there is ample room for a contender who can build trust, convertibility, transparency of reserve, and is dedicated to being legally proactive as means of mitigating counterparty risk. Crypto has seen this pattern of second-mover advantage before, where the pioneer falls victim to compliance or cybersecurity risk and fails to develop trust. Fiat-backed stablecoins are very attractive to cryptocurrency exchanges using a base-trading pair as a proxy for USD-like stability.
Collateral-Backed On-Chain
The next category is “collateral-backed on-chain”, the most prominent example being MakerDAO. These projects attempt to engineer stability by financially incentivizing participants in their network to manage volatility. In the MakerDAO ecosystem, “collateralized debt positions” (CDPs) can be created by locking up an amount of cryptocurrency worth more than the corresponding stablecoin-denominated amount issued. Their stablecoin has a soft-peg to the USD, and market-participants are incentivized to create or liquidate CDPs to keep the price stable. A second governance token, MKR, is also issued and its holders get to vote on a set of economic parameters that govern the ecosystem. The MKR token is printed as a lender-of-last-resort in the event of under-collateralization (imagine a scenario where volatile assets held in CDPs, such as ETH quickly fall in price) which could penalize MKR holders. It is yet to be seen whether MakerDAO can sustainably incentivize MKR holders to manage stability as reliably as the Fed. MakerDAO can actually benefit from using fiat-backed IOU tokens as collateral, as this diversifies their portfolio of assets.
Seigniorage Shares
“Seigniorage shares” approaches are perhaps the most ambitious, with projects like Basecoin essentially trying to create their own money and algorithmic Fed from scratch. On top of that, they attempt to compensate investors. Financial securities lawyer Preston Byrne has written a somewhat hyperbolic, yet mostly intelligent opinion on such projects. Perhaps Byrne may have been a little too harsh; after all, the US government displayed the same audacity when they made the USD the law of the land. However, he does expose the many nuances involved with managing currency that technologists will inevitably have to relearn through failure-
When the white paper’s authors speak of Fed “open market operations” as being the Fed creating bonds, or conflate monetary and fiscal policy, they betray an ignorance of finance requiring at least a two-year postgraduate master’s and several years’ work experience to cure. This lack of practical knowledge has led them to make assumptions so obviously faulty that the operating thesis of the entire project is undermined.
Seigniorage shares projects remind me of a documentary I watched recently on Kalu Yala. Kalu Yala is a site in Panama where college kids spend their summers attempting to build an “environmental-for-profit” village from scratch. In Kalu Yala, starry-eyed millennials quickly got hit with a wave of reality as their water pipes broke and they got bogged down with politics. They probably left Kalu Yala with a fresh appreciation for the institution of civil engineering and governance structures that they took for granted.
Revolutionary experimentation is healthy, but I’d put my money on viable evolution
I don’t intend to be overly critical of projects like Basecoin or MakerDAO; experimentation is an antifragile process that has made America great. What they are attempting to do is currently revolutionary, as it involves scrapping an existing institution and redesigning it from scratch. However, the most probable iteration that will evolve the crypto-economy will be to leverage the existing stability of the Fed. Hopefully one day we will see a purely decentralized “central” bank, and perhaps the team to achieve this will be a future incarnation of the Maker or Basecoin teams. However, it’s unlikely to be the next viable step.
The revolutionary disruption that is blockchain technology has already been unleashed onto the market. To drive its mainstream adoption so that this technology may realize its full potential, growth is unlikely to happen in additional revolutionary leaps and bounds. History and nature suggest this. Mainstream adoption will organically follow the path of evolution.
