Algorithmic Stable Coins: Are They Possible?
In a world without volatile cryptocurrencies, we wouldn’t need “Stablecoins”
The whole proposition of a stable asset like real estate or stocks is preposterous. People invest in assets with an expectation of profits, other wise they would just hoard cash. And therefore no one needed another “stableasset”.
So, why are the rules different when it comes to crypto? What creates demand for an asset that will remain “stable” against their cash, when there was no such precedent in other assets?
People could just hold cash.
Stablecoins will only exist during the speculative phase of crypto adoption.
Given that the primary use case for cryptocurrencies at this moment is speculation, when people speculate, they need to be able to assess the profitability of their trades in a currency unit that they are familiar with. Usually the dominant form of exchange in their country serves as their mental reference or “unit of account”. They need to be able to easily and quickly get in and out of their fiat into crypto, when they want to preserve purchasing power during extreme volatility, a predicted run down in price or when they are inactive in trading. And they want to be able to calculate their P&L in a currency that has relevance to them.
For many current crypto users, a stable coin is a unit of account and a temporary shelter during “flight to safety”. They couldnt easily do that with fiat because of the following hurdles:
- Fees: When you need to sell and buy your crypto for USD, it costs money. For example, Coinbase charges upto 9% per transaction when you sell or buy crypto.
- Buying and selling crypto has tax consequences, given the way it is treated by IRS.
- Loss of privacy/psuedonimity: Touching fiat typically causes a loss of financial privacy or pseudonymity that cryptocurrencies such as Bitcoin provide.
There are two kinds of Stable Coins:
1. Centralized Stablecoins
2. Impossible a.k.a “Algorithmic” Stablecoins
1. Centralized Stablecoins:
Any asset can be stabilized in exchange rate against any other asset, if there is free, frictionless convertibility between them, and a full, trusted reserve at all times.
However, “trusted” is the difficult part. There is no way for any user to surely know if someone actually has the said collateral backing their tokens, sitting in a vault. And that is because,
The “Blockchain” doesn’t have a magical entanglement with the real world.
The blockchain cannot track what you do with your USD. It doesn’t know, what happens outside of the closed network of computers writing on that chain. So, you are back to trusting auditors, bank statements, regulatory agencies etc for assurances that your collateral exists where it’s supposed to, and that it is redeemed when it’s needed to. Which then again brings us back to square one, trusting central authorities.
There is a possibly a way to decentralize a fully asset backed stablecoin by distributing collateral among many parties, and incentivizing them to always hold the collateral in full reserve and redeem as needed. It may be possible to do this by randomizing the threat of a bank run, using a zero knowledge approach such as “Provisions”. If it can be guaranteed that if some node that issues a coin doesn’t redeem when asked, it risks losing money in excess of collateral held, this will work. But, that requires the value of deposits to be held somewhere, and having the deposits in a volatile cryptocurrency brings us back to the same problem we are trying to fix.
It may be possible for decentralized prediction markets or oracles to provide the missing piece for decentralizing fully collaterized stablecoins. However, I am not aware of any projects that were have solved either of these.
Which leads us to the second form of stable coins, the impossible ones.
2. Algorithmic Stablecoins:
“Money is a means of exchange. As such it is subject to peoples’ actions and valuations in the same way that all other economic goods and services are. As a result, money’s subjective and objective exchange values continually fluctuate, and there is no such a thing as the stability of the exchange ratio of money vis-à-vis other goods and services; in a free-market economy there aren’t fixed exchange ratios” — Ludwig von Mises
Algorithmic stablecoins rest on the assumption that one can somehow “stabilize” the exchange rates between different goods, by some combination of clever marketing, CS jargon with a healthy dose of Keynesian gibberish thrown in. Usually these pyramid schemes have names that sound authoritative and convincing, such as “Seignorage Shares”.
This much touted scheme assumes that people will always demand the ability to buy future seignorage shares, meaning that future participants will always believe in an unending demand for the stable coin, and therefore attempt to profit from it. How do the issuers know this? They don’t. They just assume it away. Some have attempted to put even more fanciful tools such as “Bond Queues” to make this idea viable. But ultimately, they are all attempting to invent a perpetual motion machine that is as impossible praxeologically as a perpetual motion machine is impossible physically.
All algorithmic stablcoin approaches depend on economic calculation that is bounded not by computational limits but by the fundamental impossibility of knowledge. For their schemes to work, the nodes need to “read” or acquire data from future human minds about what their preferences will be and determine what future prices will be.
And that is the exact reason why these schemes will fail, but not before raising gazillions of Venture Capital from supposedly intelligent venture capitalists interested in disrupting this or that.
Is there such a thing as “Stable” money?
An absolutely stable coin is an anti-money. It’s an absurd money that cannot exist. The stupidity of “algorithmically stabilizing prices” starts with misunderstanding what prices are.
Prices are information systems that enable inter-temporal coordination of resource allocation. They reflect the valuations of all participants in trade. These valuations are not cardinal but ordinal. Meaning that people value goods and services, including money, in an order of preferences and not in absolute terms. For example, if today a man does not value $50 worth of clothing more than having $50 in his pocket he will not make the purchase. Tomorrow, if he does, he makes the purchase. His change in preferences will be reflected in demand, and ultimately, in prices.
And his preference is not time invariant, and is constantly changing. And how it changes can only be observed in action and cannot be predicted with absolute certainty. Prices and exchange rates just reflect these continuously changing valuations and preferences, and therefore always fluctuate.
Therefore, “stability” is not an attribute of any market good. The exchange rate of any good vs any other good comes from subjective preferences of people, expressed in terms of supply and demand for those goods, ultimately expressed in prices. These constantly change as people choose among alternatives continuously. These changes are influenced by other people’s preferences, external and internal factors, and randomness, these changes are unpredictable and unimaginably complex.
Trying to fix the exchange ratio of a coin against another good (fiat), implies that the coin issuer somehow magically knows what everyone’s preferences will be in the future. This is self evidently preposterous.
But what about Bitcoin? Will it ever be stable?
Yes. During the period of precious metal money, because the quantity of money in circulation changed predictably and slowly, CPI was relatively stable, meaning that though the exchange rates fluctuated, the money provided “Accounting Stability”. Note that this is not absolute stability in terms of exchange rates, but convenient enough for people to be able to perform economic calculation. So, we don’t need a stable coin. We need a money that has a predictable but slow or no change in quantity. Oh, guess what, we have Bitcoin!
Once Bitcoin becomes the generally accepted medium of exchange and a store of value, all goods and services will be priced in Bitcoin, and magically, we will have sidestepped this supposed catastrope of price volatility. It may take time, but that is exactly the path to having “stable” money, which is stable enough for economic calculation for everyone.
