Use Cases for Decentralized Money (Stablecoin)

I’ve been reading a lot of stable-coin white papers lately. Though somewhat different in mechanism design, each start out the same way: 1) claim price-volatility is the primary roadblock from BTC reaching the mainstream, and 2) predict that a price-stable coin will (finally!) be used in everyday life.

I don’t intend to bash the competition — Terra’s white paper (penned in part by yours truly) is no different. Though simplifying the problem surface is effective as a PR play, in all honesty, solving Bitcoin’s problems does not a use case make. We need to soberly recognize that Bitcoin itself does not have proven mainstream use cases, and that we are closer to having to start a decentralized revolution from scratch than to riding out its waves.

A stable-coin offers subpar investment returns, and therefore derives most of its value from its useability. In thinking about use-cases for stable-coins, we need to ask the hard question of why currency is better off decentralized. I find that the most popular arguments for decentralized currencies are not applicable to mainstream use cases. But that is not to say good use cases for crypto don’t exist; there exists great use cases, and some have serious potential to be truly revolutionary.

Bad arguments for decentralized money

Here are the two most often used arguments for cryptocurrencies.

• “Cheaper and more efficient”
  This is partly true: a Bitcoin transaction clears more quickly than a SWIFT transaction and is generally cheaper. But I would argue that this is largely because the Bitcoin economy has not yet entered steady state. Most miner rewards are still paid out in inflation, and once that stops, the reward economics will have to switch over to transaction fees; expect transactions to become more expensive then. Furthermore, credit card companies & other fiat based financial services providers provide services that make payments easier in exchange for fees. Likely, if Bitcoin is to be used more widely, we will need traditional balance-sheet driven businesses charging fees in exchange for services and driving adoption. This too, will drive up costs.
• “Trustless store of value”
  Most people (at least in the developed world) don’t have much trouble “trusting” that their bank accounts are secure from seizure and default. This argument is more in the domain of libertarian political theory, and not in that of mainstream economics.

Good arguments for decentralized money

I maintain that there are some excellent reasons for decentralizing money. The primary functions of currency are value store and value transfer. If a cryptocurrency can serve these functions better than fiat, then it is a superior form of money. Terra can immediately return value being lost via seigniorage, and will eventually be able to bypass restrictions on fiat value transfer.

Eliminate deadweight loss in wealth management & distribution
I would argue that while price-stability and decentralization are interesting properties for currency, the real exciting opportunity lies in programmatic distribution of seigniorage. Fiat central banks use the “hidden tax” of inflation for political reasons, much of which is wrongly and wastefully distributed. On the other hand, a decentralized protocol has no interest in politics. Instead, it can distribute seigniorage back directly to the users to drive usage and adoption. An example of this is e-commerce discounts, which is the centerpiece of Terra’s early go-to-market strategy. Terra Pay users are rewarded for helping to grow usage and adoption of the economy. Later down the line, seigniorage can be used for many creative purposes, as outlined in the second legend.

I often get asked, what happens when the economy reaches steady state and starts growing more slowly, say, 2% like the US economy? The short answer is that 1) it will take a long time for stable-coins to reach steady state with respect to a national economy, and we must therefore account for GDP growth + adoption growth, and 2) seigniorage is quantified in nominal GDP growth, and therefore is real GDP growth + adoption growth + inflation. For example, though real GDP growth in the US was around 2% in 2016, nominal GDP growth in the same year was above 8%.

Users who contribute to the growth & adoption of decentralized currency can expect to reap its gains instead of seeing it wasted in political deadweight loss.

Increase the design space for financial products

Finance is one of the most heavily regulated industries, and often for good reason. But the user experience of finance is riddled with too many licenses, restrictions, audits, and agreements, to the extent that the solution space is limited and meaningful access is denied to billions. The beauty of decentralized currency is that it cannot be regulated or shut down, so we can increase both the variety of financial products and the people who have access to them. Here are some things that become possible with a working stable-coin:
- universally accessible credit (no limits on interest rates)
- insurance
- international banks without infrastructure or borders
- gifting

A stable-coin will be able to improve upon what Alipay did for the digitization of personal finance by expanding accessibility and variety. Moreover, such a currency will be permission-less and open, such that it will rely on the collective ingenuity and industry of the entire community instead of that of one company.

How Terra plans to become useful and used

Some believe that once a new form of currency is created, adoption will come naturally. On this, I quote directly one of the founders of a well-known stable-coin project: “Arguably a stablecoin that leverages the appropriate benefits of distributed ledger technology (or targets the right verticals) has more than enough of a value proposition to encourage adoption.” I think differently; technology is only useful if it gets widely used. In the current crowded marketplace, I believe that driving adoption will be the most important challenge and differentiating factor.

Luckily, there exists an early-stage rulebook that have been followed by previous innovations in personal finance. It is actually very simple: 1) drive massive volume in payments, and 2) leverage network effects to build auxiliary products on top. Alipay and WeChat have successfully replicated every financial product on their platforms, because they have massive existing networks of users and merchants transacting on the platform.

• Become a medium of exchange at scale through Terra Pay
  Financial incentives through seigniorage discounts brings the most immediate and obvious benefits to early adopters for the least amount of technical effort. As we drive transaction volume by signing up partners, GDP growth will be massive, making the mint busy in rewarding consumers for purchases. This in turn creates a positive feedback loop that leads to further seigniorage. Though this may seem like a “perpetual financial machine,” positive growth feedback loops are indicative of value skews that occur when economies with zero capital controls compete with different prices, and incidentally, how the United States gained its economic hegemony post WW2.
• Incentivize store of value through financial products built on Terra Platform
  The design space of products that can be built on Terra Platform is near infinite. Any product related to the store or transfer of value can be created on Terra. Reverse ICOs using a stable token, gift cards, and basically every ICO project claiming to decentralize the world can be re-written on top of a price-stable currency.

I outline five product classes with the biggest potential:

1. ICOs (Decentralized organizations)
   Every dApp must have underlying currencies to be useful in transactions, but are not capable of defining stable-coin schemes themselves. By creating an alliance of ICOs through Terra Platform, we can both offer stability as a service to many dApp economies, and strengthen Terra’s own stability by diversifying transaction fee income streams. Furthermore, a stablecoin ICO can help to offer a stable haven for ICO funds raised through token sales, a low-hanging fruit value proposition given that banking services for ICO projects in most jurisdictions are rather limited.
2. Insurance
   Insurance boils down to charging fees based on risk, and collateralizing realization of that risk. If that sounds quite similar to transaction fees from Terra and collateralization via Luna, that’s exactly right. A very successful Terra based insurance business can be built, with fees collected in Terra and payouts backed by the Luna reserve. The added advantage is that we would be free from most insurance regulations, and can use whatever standards we like to calculate risk.
3. Decentralized marketplace
   There are many projects claiming to build decentralized marketplaces. Most of these projects are not practical, given that dealing with fraud and quality control over a decentralized protocol is near impossible. However, we can create a more trusted marketplace with our existing list of e-commerce partners from the first phase (already trusted by millions of users), and maintain a positive user experience.
4. Credit
   Though building credit on the blockchain is non-trivial, credit simply does not exist for a vast majority of people in the world. By connecting high-risk microcredit cases with lenders with margin-trading appetites, we can create a viable credit market in developing countries without existing banking infrastructure.
5. Payroll
   As the financial ecosystem built on Terra Platform becomes richer, Terra will no longer just be used as a means of payment, but also as a store of value. Alipay has successfully become a closed economy, with internal cash flows / inflows vastly exceeding cash outflows from the system. Likewise, at scale, we will be able to see organizations being built that raise funds, do payroll, and keep accounting books in Terra.

Painting a picture

At steady-state, decentralized currencies allow the creation of financial infrastructure that is beyond the reach of regulations & borders. Regulation and centralized infrastructure has constrained both the innovation and accessibility in financial goods and services, and decentralization via adoption of a stable-coin can unshackle both. Exciting!