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Decentralized Stablecoins at the Center of the Future of Finance

Is An algorithmic stablecoin like PAR better than fiat pegged centralized stablecoins?

2020 was the year of stablecoins. At the beginning of the year, stablecoins had an outstanding supply of $5 billion. That figure had risen to $20 billion by October 2020. Stablecoin use has exploded right along with the growing DeFi market, as traders leverage the stablecoin’s faster arbitrage opportunities.

Stablecoins are a crucial blockchain innovation. They are key to the crypto mass adoption process, bringing in users to DeFi that would in the past not touch the volatility of cryptocurrencies with a long pole.

Mimo DeFi’s $PAR, for instance, is the only decentralized, algorithmically-pegged, Euro-backed stablecoin on the market. So Euro users, wary of crypto price instability, can use the Parallel Protocol or PAR stablecoin and access the growing DeFi market.

The Parallel Protocol is Mimo Capital’s algorithmically backed stablecoin. PAR and the Mimo governance token work as a tag team, decentralizing PAR’s governance protocol and stabilizing PAR’s price via smart contracts, algorithms and collateralized debt protocols.

Growing Stablecoin FUD

There is a growing FUD or Fear, Uncertainty, and Doubt over the safety of stablecoins as China flushes out commercial Bitcoin miners from its shores. There are also suggestions that BTC’s price is pumped by the issuance of stablecoins such as Tether’s USDT.

You can unpack most crypto FUD through research. As an illustration, cryptocurrency price discovery mechanisms work simultaneously across multiple exchanges. Then again, the USDT market’s $62 billion market cap is but a fraction of Bitcoin’s $680 billion large market cap, so it may only influence BTC’s price minimally.

Fear flooded the market due to uncertainty over fiat-backed stablecoin’s zero asset backing. However, it is a crucial cryptocurrency market security problem. Stablecoin’s low or zero asset backing could spell doom for stablecoins, as you will find out below.

Stablecoins are a developing blockchain asset class that seeks to establish price stability in a volatile crypto-asset industry. By maintaining their value over time, they are well suited for everyday use, unlike volatile bitcoin. They are also low inflation tokens, encouraging users to spend them like they would with fiat currencies. As a result, there is little need to ‘hodl’ a stablecoin or use it as a savings vehicle.

To achieve price stability, the most popular stablecoins peg their value to traditional finance currencies. Fiat-collateralized stablecoins maintain a 1:1 value with centralized currencies such as the US dollar. To this end, they have a fiat currency reserve which backs their tokens.

A few other tokens have a 1:1 peg with valuable commodities like oil or precious metals such as silver or gold. Therefore, a USD backed stablecoin holder could easily swap their stablecoin for USD.

It follows then that since fiat-collateralized stablecoins have a central reserve, they have reserve custodians. These stablecoins, therefore, are centralized, contrary to the blockchain’s ethos of decentralization.

The Risk of Stablecoin Centralization

Tether’s USDT is currently the world’s most popular centralized stablecoin. For this reason, a lack of transparency in Tether’s audits or fears of low fractional reserves may make the use of fiat-backed stablecoins a moot point. You could be changing your hard-earned fiat currency for valueless stablecoin assets.

A lack of transparency in stablecoin management and fractional reserve structure is a rich source of stablecoin-use fear. Crypto users, for instance, have long been wary of Tether’s 1:1 peg with the US dollar. There have been fears that the USDT lost its 1:1 peg with the USD when Bitfinex, its sister company, took $850 million from Tether’s vaults to cover lost user and corporate funds.

Tether settled their NYAG lawsuit, and they have also tabled complete audit reserves. Moore Cayman, part of the London based Moore Global accounting firm, released an assurance opinion in February 2021, stating that all USDT in circulation is fully backed by USD.

If the Moore Cayman report is to be trusted, then all Tether holders should effectively swap all their stablecoin for USD should there be a catastrophic failure in its system, right? Well, stablecoins have not had a bank run type of situation yet. For this reason, only time will tell the effects of a failed stablecoin peg. That said, we can infer possible side effects of a failing stablecoin studying the traditional finance’s most recent bank runs.

In 2007, Northern Rock bank was Newcastle United’s team shirt sponsor. Northern Rock was emerging as a financial service giant, playing hardball with the prosperous giants of the south. Northern Rock had started as a building society to emerge as the UK fourth-largest bank.

Its executives praised their outstanding performance in their annual report, calling 2007 an excellent business year. “Our strategy of using growth, cost efficiency and credit quality to reward both shareholders and customers continues to run well, “said Matt Ridley, the Northern Rock chairman.

Unknown to the public was that Northern Rock had gone overboard its lending ratios using international money markets credit as homeowner credit. They should have, in essence, only used part of their customer’s deposits as credit. At the first sign of the North American subprime crisis, the international money markets ceased lending to housing market institutions.

Shortly afterwards, Northern Rock had its bank run. It was the first bank run in 150 years of UK banking history. When it turned to the Bank of England for support, its customers queued outside its branches to take out nonexistent deposits. The bank run took the city by surprise.

“There was a queue outside going right down the street. That really was the first sign that something was wrong. No-one really saw it coming”

…says Newcastle City Council Councilor Nick Forbes. Some of Northern Rock’s shareholders lost all their life savings. Northern Rock’s fiasco was a precursor of the massive credit crunch that would hit the global financial system in 2008. The government took over Northern Rock in 2008.

The Importance of Stablecoin Safety Reserves

The 2007–2008 credit crunch was also a high-tech bank run. The global financial industry’s lax lending standards created a housing bubble that was further escalated by the Federal reserve’s low-interest rates of 1% in the early 2000s.

Mortgage rates were rock bottom, and subprime borrowers with low credit histories could access credit to buy their dream home. Banks, therefore, lent beyond their deposit capacity, packaging the debt as collateralized debt obligations or mortgage-backed securities. Wall Street banks were happy to create a market for subprime loan products.

The Fed, however, began to raise rates in 2004, causing distress in the subprime market. By 2006, many homebuyers were in financial distress, and prices were crashing, lowering the value of previously high-priced homes. Eventually, homeowners were stuck with mortgage rates that they could not meet.

Soon these subprime lenders were filing for bankruptcy, causing a domino effect on the financial markets. The Federal Reserve had to step in, buy these toxic assets and print billions of dollars to subvert an economic doomsday event.

The 2008 banking crisis was the largest bankruptcy season in US history. Unfortunately, bankers were rewarded with a $442.6 billion kitty for recklessly playing around with the global economy. The history of the financial industry’s bank runs, and their devastating effects highlights why the stablecoin protocols should hold safety reserves and not circulate coins that they cannot back with actual pegged assets.

Stable coin issuers should be transparent and fiscally responsible. The cryptocurrency market is unregulated and often at loggerheads with the mainstream financial sector. Should a poorly managed stablecoin project fail, customers have no regulator to turn to. Also, this may end up affecting DeFi liquidity pools balanced with stable coins, creating a domino effect that could negatively impact the blockchain industry as a whole.

Traditional banks practice fractional reserve banking to protect depositor funds. Under fractional reserve banking, the institution holds a percentage of customer deposits in its vaults and then lends other deposits to the credit sector for profit.

The fractional reserve banking system ensures that the ordinary customer has access to their funds when they need them. In the US, the Federal Reserve set a 10% fractional reserve limit for banks with liabilities over the $124.2 million mark. But, shockingly, the Fed dropped its reserve limit to zero in March 2020.

Should there be a reason for a bank run, banks would probably not have much to meet their customer’s basic withdrawal needs. Fortunately, customers who deposit here have Federal Deposit Insurance Corporation (FDIC) protection. Established in 1933 to build user confidence in banks after the great depression series of bank runs, the FDIC insures deposit accounts up to $250,000.

Fiat-Backed Stablecoin’s Low and Risky Cash Reserve Custodians

Pundits such as Frances Coppola of “The Case for People’s Quantitative Easing” argue that some centralized stablecoins create money out of thin air as commercial banks did with their subprime mortgage financial instruments.

Much of the world’s M2 supply is a result of the shadow banking system. These financial organizations operate like banks but are not under the regulation of government central banks. Shadow banks profit from the massive money market fund sector as well as hedge and private equity. They make enormous profits also from the insurance industry.

Shadow banking creates eurodollars, banking them in low regulatory stance regions like the Bahamas and the Cayman Islands. For this reason, eurodollars accounts are not FDIC insured, or US Federal Reserve backed. For example, Deltec, Tether’s banking partner, is a shadow banking institution in the Bahamas.

It is, therefore, possible that part of USDT cash reserves is eurodollar based. In March 2021, Tether announced that it only had 26.2% of its reserves as cash. 49.6% of its reserves are commercial paper. All of USDT’s USD reserves may therefore not adequately meet a flash liquidation situation.

Centralized stablecoins may never have bank run situations. That said, what happens to user deposits when their traditional banking partners fail?

Deltec’s accounts are not under US jurisdiction, so Tether’s deposits do not have FDIC insurance. Many centralized entities in the crypto world use shadow banks such as Deltec as reserve custodians. For this reason, their USD pegs are faux dollar pegs. Should these stable coins peg with the USD break, their token holders will not have access to actual USD reserves.

Implied fiat exchange rate pegs can cause a massive cryptocurrency black swan event, should centralized stablecoins lend out more than they can safely guarantee their users. They would no longer guarantee the 1:1 peg.

The Future is Decentralized

For ultimate stability, stablecoins have to outgrow a fiat collateral obligation. Do Kwon of Terraform Labs says, “if you build crypto apps on top of assets that can be regulated, and I think as they get larger they are sure to get regulated, then it holds DeFi hostage. The only way you can solve this is if you come up with a truly decentralized and unbiased form of money.”

Currencies lost their gold peg decades ago and are simply government-backed assets. By the end of 2020, the Fed printed a massive $3.5 trillion to prop up a flailing economy, further devaluing fiat money.

Algorithmic stablecoins such as PAR do not rely on fiat collateral to maintain their peg. They use code and rules instead. As a result, they do not need custodians to man their safety reserves and are fully decentralized.

They are the holy grail of the stablecoin market. Algorithmic stablecoins can create a slow but sure consensus-building process to adoption that does not depend on centralized, stable coins “too big to fail” economy.

Like fiat collateralized stablecoins, algorithmic stablecoins achieve price stability by pegging their value to reserve assets such as fiat currency or commodities such as gold or oil. Nevertheless, algorithmic stablecoins rely on algorithms that control and manage vaults backed by digital assets such as wBTC or ETH, which is the case of the Parallel Protocol.

Central banks all over the world are now seeking to battle and eventually regulate fiat-backed stablecoins. Centralized stablecoins will therefore become less independent as they encounter the rising central bank digital currencies. Britain, for instance, is initiating its regulatory drive with the stablecoins sector to keep them from dominating the emerging industry.

“There is the potential for some firms to swiftly achieve dominance and crowd out other players, due to their ability to scale and plug into existing online services,” says John Glen, Economic Secretary to the Treasury. The US Office of the Comptroller of the Currency has allowed the use of stablecoins in bank payments as a step towards the creation of compliance controls.

Mimo’s Decentralized Safety Features

Algorithmic stablecoins will be free of government regulation since they are a product of code. They are therefore highly scalable, and as per the laws of economic physics, they could accumulate such high levels of collateral that they would support large financial sectors.

Algorithmic stablecoins are openly audit-able and an excellent source of trust. They are transparent and therefore are not prone to FUDs. Thus, they are the least likely candidates of a bank run scenario, fueled by fear becoming a self-fulfilling prophecy.

Like fiat and the fiat collateralized stablecoins fractional reserve system, the Parallel Protocol has a safety reserve covering all its vault deposits. Think of its vaults as a traditional bank vault. The Parallel Protocol channels 15% of all its fees to its safety reserve to ensure that its users can be protected in the event of a flash liquidation happens across the market, due to rare but possible flash crashes in cryptocurrency prices.

Therefore, the safety reserve keeps the Parallel Protocol user’s holdings safe from market manipulation effects, working much like an FDIC deposit account insurance. Blockchain technology will decentralize the information age. The financial asset that will eliminate the dominance and control that centralized governance has over the global economy will require blockchain security, transparency, and data immutability.

The Mimo Project is decentralized, leveraging smart contracts and blockchain security to keep its protocols and data safe from hacking or manipulation. The Parallel Protocol runs on the Ethereum blockchain. Its smart contract enforces transaction agreements between parties without the need for intermediaries.

Using the “code is law” ethos for efficiency, DeFi and blockchain safety smart contracts minimize transaction costs, eliminate errors and data manipulation. In addition, smart contracts transactions are cryptographically secured to prevent hackings, fraud, theft or cases of double-spending.

All Ethereum blockchain smart contracts are stored on its decentralized mainnet after verification by Ethereum nodes. Therefore, to hack, edit or manipulate the Mimo Project data, a malicious actor would have to take over 51% of the nodes on the massive Ethereum network. The Mimo project is therefore safe because it is built on a decentralized network.

In contrast, banks and fintechs store all their data on central servers. Centralized data storage creates a single point of failure that hackers can exploit for their benefit. Powers that be can also appropriate such data and assets for their self-interests.

To conclude, Mimo Project’s Ethereum-based smart contracts are secure, keeping its vaults free from hacking and data manipulation. Its depositors’ Euro assets are protected by its Safety Reserve smart contract protocol that stores 15% of all its network fees. All PAR is effectively fully backed collateral.

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