How a Gambling Scotsman Invented the First Stablecoin in 1704
A guide to Stablecoins, bananas and 18th-century monetary politics
In the past weeks I’ve talked about Security Tokens and various forms of alternate investments, so, after not posting an article last week in accordance with Blackout Tuesday, it’s time to finally talk about stablecoins.
What are Stablecoins?
A stablecoin is a cryptocurrency that’s linked to one or more underlying assets in order to minimize volatility. A cryptocurrency that isn’t volatile might sound like a strange concept to some, but keep in mind, many had the hope Bitcoin or altcoins would be crash-resistant and uncorrelated to the market. When Bitcoin crashed harder than half the market during the recent corona crisis, it once again became clear bitcoin would not fill that role. (At least in the near future).
The way most stablecoins achieve their stability is by being pegged to an underlying asset. That asset can be a commodity or another currency, which can be either fiat or crypto.
Commodity-backed stablecoins
Commodity backed stablecoins are, as the name suggests, pegged to underlying commodities or trade goods. When looking for a commodity to link your stablecoin to, obvious choices include gold, silver, and… bananas?
If you think a stablecoin backed purely by bananas is a bad idea you’re probably right: The Bananacoin was issued in September 2017 and was pegged to the export price of “Lady Fingers” bananas. While the initial coins were sold for $0.50, they are today worth about $0.02. This issue of a stablecoins peg not holding up to the price of the underlying asset is a reoccurring theme with stablecoins unless they can directly be exchanged for the underlying asset.
Crypto-backed stablecoins
Backing a cryptocurrency with another cryptocurrency in order to make it more stable sounds foolish at first, but a stablecoin can theoretically be pegged to a whole basket of cryptocurrencies, meaning you can build up a portfolio just by buying the stablecoin. That being said, since most altcoins are heavily correlated, creating a low volatility basket is still a challenge.
Fiat-backed stablecoins
A cryptocurrency that’s not volatile and maintains a stable exchange ratio to a fiat currency like the USD or the Euro sounds like the perfect way to connect blockchain-based currencies and traditional currencies, but unfortunately, it’s not that easy.
Currently, the most popular fiat-backed stablecoin is Tether (USDT), which is supposed to maintain a 1-to-1 ratio with the USD. While Tether is admittedly very stable and hovers around a price of $1, there are a lot of controversies around the currency, partly because the company never showed having adequate reserves to back the currency and partly because owners have no actual guaranteed right to exchange the currency for USD.
Facebook's Libra (should it ever launch) is also planned to be a stablecoin backed by a basket of fiat currencies, but Facebook is still trying to get the currency past US regulators.
Unbacked stablecoins
Yes, stablecoins that aren’t backed by anything exist. They’re also called algorithmic stablecoins or seignorage-style stablecoins. The way the prices for these coins are regulated is by creating or destroying currency to have a consistent ratio of supply to demand. While this sounds overly complicated, unsafe, and hard to execute in practice, there is one fact that should be kept in mind: Central banks regulate their respective fiat currencies in the same manner, by adjusting money supply. On blockchain, this regulation of money supply can be automated, eliminating the trust factor.
John Law
John Law was born in 1671 in Edinburgh and had an uneventful upbringing until he killed a man in a duel in 1694, had to flee Scotland, and started traveling Italy, making his living as a successful gambler. He might also be the father of stablecoins.
What does a gambling Scotsman have to do with stablecoins?
In 1700, Law was allowed to come back to Scotland and started contemplating contemporary political and economical problems. At the beginning of the 18th century, national banks were still a novelty and the recently established bank of Scotland ran into liquidity issues. While they were technically not insolvent, the available amount of silver coins in Scotland was so limited that the central bank could not pay its expenditures. John Law thought that the gold and silver standards that countries used at the time were flawed, as the supply of gold and silver was fluctuating heavily, leading to people melting down their coins whenever the coin's gold value was higher than its face value.
To create a stable currency, John Law wanted to link his currency to a stable underlying asset. Sounds familiar? Law’s idea was to have land as an underlying asset for a paper currency, as the supply of land would not fluctuate. He made further arguments for his idea of a land-based currency, stating that linking currency to land would also link economic and population growth to land, guaranteeing steady, non-inflationary growth.
While his proposal in this form was rejected, he was later tasked with implementing a government debt-based paper currency in France, which, after initial success, failed spectacularly, forcing him to flee France in 1720.
Nine years later, John Law died lonely and poor in Venice. While his contributions to monetary theory are controversial and still being heavily discussed today, had he in the current age, chances are we could buy the JohnLaw Token, worlds first land-based stablecoin.
