Barriers to Stablecoin Adoption: Detaching from the Traditional Notion of Markets

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ReverseAcid

8 min readFeb 17, 2019

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Current Stablecoin Landscape

Despite the hype around Stablecoins, the practical disadvantages outnumber the benefits tremendously. As a believer in the potential they hold, most of the existing stablecoins do not offer something too different from fiat currencies. Other than the fact that it is money that is cryptographically secured and can be transferred across the planet at a faster speed (some don’t even offer the speed), it is ultimately just digital fiat that is issued by a non-governmental entity. While the ‘anti-censorship’ argument can be made, it is relatively simple for the government to seize the fiat that serves as collateral for the stablecoin.

Just to explain this, let’s create a hypothetical situation where the US government wants to cause havoc on USD Tether. This also includes the assumption that Tether actually has USD reserves to back their tokens (they most likely do not). Through the Federal Reserve, the US government can freeze Tether’s bank account(s) that contain their collateral. In case you were wondering, yes, they do have the power to do this legally, as does every country’s government. Back to Tether, news of this would cause a massive selling off of Tether in secondary markets causing their peg to collapse big time. It wouldn’t be the first or second or third time Tether’s peg to the USD breaks, but it would be enough to cause the biggest deviation so far. In late October 2018, Tether was plagued by the news that whales and other traders would be abandoning it. This caused a huge sell off that in turn also pumped Bitcoin and Ethereum as it was what most people purchased in exchange for their Tether. That week Tether plunged 16% to $.84.
So just what exactly is the problem with these fiat backed stablecoins? There are two major problems that require the majority of your attention so let’s jump right into this.

1. Breaking the Fiat Link

Any stablecoin that has gained recognition like DAI, Tether, and UDSC have one fundamental flaw: they are linked to the dollar. Recreating a digital dollar and backing it on a 1:1 basis may be an effective way to create a stablecoin, but the long term outlook for such coins is dim. To make this easier to digest, here’s a list of why it is necessary to break the link to fiat currencies:

• Whether it’s a direct fiat peg or an indirect one, you are ultimately just creating the digital version of the currency. If it’s tied to USD, EUR, or GBP it’s a direct peg. If it’s tied to gold, silver, or some other commodity that is primarily valued in dollars, it is an indirect peg. Now again, if the stablecoin is tied to a basket of every day commodities like CPI or WPI, you are once again just creating an indirect peg with the illusion of a pure inflation peg. All of this is similar to Maduro introducing a new currency that is pegged to the old currency and saying that it has “ended dollarization in Venezuela”. The only advantages here, if any, are speed, cryptographic security, tougher to implement censorship, and ease of cross border transactions. Simply put, if the USD goes through a bit of a trough, so does your stablecoin. If inflation in the country of the currency the stablecoin is backed by soars, your stablecoin’s inflation also soars. This is because irrespective of the supply and demand for the stablecoin, by pegging the value to an existing currency, you import their inflation no matter how your stabilization mechanism works. This stabilization mechanism changes inflation of the coin just to maintain the peg; the real value still lies in the currency it is backed by.

• Fiat backs the global economy. This is an indisputable and obvious fact. So even if you have a stablecoin backed by a lamp, aluminum, or water vapor, you will end up importing inflation from the fiat world. This cannot be helped for the near future because to buy into crypto, one must use fiat currencies. Irrespective of what your stance on the issue is, the fact of the matter is that decoupling from fiat in terms of pricing a stablecoin or valuing Bitcoin, Ethereum, or any other crypto asset is going to be one of the most difficult yet game-changing challenges.

2. Fiat is Stable because of Inherent Faith in Governments

In his bestselling book ‘Sapiens’, Yuval Noah Harari explains how everything from money, governments, security, and every other concept in humankind is just a story. That is, it exists and functions because we believe in it. The day we stop believing that particular story is the day it ceases to exist.
Long story short; fiat works because we believe in it. If one day 300 million Americans woke up and decided they longer believe in the US Dollar, the currency and the Fed would collapse. The beauty of decentralized currency is that a government cannot stop it from functioning; the drawback is they can stop you from accessing the internet.

Just like stablecoins have mechanisms in place to manipulate supply and demand, fiat currency is even easier for central banks to manipulate. In fact, the entire reason for stability other than our belief in the system is that most countries follow a ‘managed float’ currency valuation which allows them to print, sell, and buy money as and how they require. It is much easier for a central bank because centralization is by default much easier to carry out than decentralization. Central banks can directly go to the open market and do what they need to do; decentralized stability protocol requires hundreds or thousands of hours of brainstorming and debugging to even set up. It takes more intellectual and financial resources to find a way to implement this in a distributed fashion.

Then the point of crypto is to eradicate fiduciary trust in governments and monetary authorities. So it is obvious that we cannot have a stablecoin that manually manipulates circulation and issuance. You trust a government because it’s transparent to some degree and there are a group of people to hold accountable if something fails. Would you trust a private entity to perform these same functions? I thought not. The reason we have faith in the government is because we see a face to blame if something goes wrong. This creates the inherent faith in the system that has powered our society for millennia. From monarchs to democracy, we have technologically advanced but we have the same primitive belief system.

What is the Solution?

Algorithmic stability mechanism is the answer; but what do we back them to? Basis Protocol, previously known as ‘Basecoin’ was a personal favorite of mine. They had the idea to issue share and bond tokens so as to contract and expand circulation to keep their peg intact. Their plan was to peg it to the US Dollar and eventually move it towards an index of assets or commodities. While this still maintains the indirect peg, it was the best solution to the stablecoin problem I had seen thus far. Unfortunately, on 13 December 2018, Basis announced they would be shutting down and returning people’s money because of the classification of their share and bond tokens as ‘unregistered securities’.

It was during this period that I came across a new project. While browsing through Medium, I saw a certain individual named ‘Nevin Freeman’ had written a review of the Basis protocol sometime in mid-2018. Some of his arguments were sound and very much legitimate, but I have to respectfully disagree with his perspective on some of the points put forth. Nevin is the CEO and co-founder of Reserve: a stablecoin project in Oakland, California. Upon reading their whitepaper, I was quite fascinated. Their viewpoints match the exact essence of this article; detach from fiat so as to avoid importing all the problems plaguing them.

Reserve plans to peg their token to a basket of assets that they call ‘The Vault’. This basket is more or less a portfolio of both on-chain and off-chain assets. This means it would include crypto assets as well as real world assets. With the help of a decentralized oracle, they will have an algorithmic monetary policy that contracts and expands circulation based on the value of the vault. Reserve creates a band and defends that band through its stability mechanism. If there is an instance of significant appreciation or depreciation, the algorithm has the power to widen the band. For the more finance savvy readers, this band is just a spread between the redeeming and issue price to prevent drastic mispricing that makes arbitrageurs extremely happy.

Conclusion

The stablecoin ecosystem has a long way to go. There is an unfathomable amount of research and dedication that needs to go into the space. Luckily, the process has already begun. With pseudo-loan issuers like MakerDAO to future-proof solutions like Reserve, we are witnessing the beginning of something beautiful. While Bitcoin was built to be P2P cash, the volatility is far too much for somebody in a country with a relatively stable economic climate to use. We will one day see it become a store of value when the market gets a little more mature and the number of participants increase. When that day comes, it will still not be feasible to make frequent micropayments in Bitcoin.
Finding a solution to the current stablecoin situation is a necessity. We are already in the process of uncovering not just one, but many. As the technology and systems develop, the best solution will naturally emerge.

Please do have a look at my Previous Article on Stablecoins here

AB

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