Stablecoins are a foundational pillar for the blockchain-based financial system. A stablecoin, when properly implemented, can serve as a medium of exchange for a new ecosystem of financial contracts, applications, and businesses.
But until recently, cryptocurrency markets have been hurt by a lack of trustworthy fiat-backed stablecoins. While there has been a surge of new stablecoin projects, there has not yet been an industry-wide dialogue about what it will take for a fiat-backed stablecoin to be trusted as an integral part of the industry’s infrastructure.
What are the core principles a trustworthy fiat-backed stablecoin will follow?
In the future, regulators may establish more clear policies for digitized currencies. In the meantime, fiat-backed stablecoin projects can take the initiative to hold ourselves to a high standard of ethics. While our specific approaches may vary, there are at least a few lessons from the past we can agree stablecoins should not repeat.
We invite all fiat-backed stablecoin projects to commit to these principles. We welcome your feedback for revisions and additions. This post is the start of an ongoing dialogue. Together, we can build a more trustworthy future for the ecosystem of people and businesses that rely on stablecoins.
Lessons From History
First, we’ll describe the ways a fiat-backed stablecoin can lose utility for its users. Under each misstep, we propose the best practices that fiat-backed stablecoin issuers can take away from it, in order to create lasting value for their users.
Proof of Funds
As many have reported, Tether has not consistently provided up-to-date proof of funds, and one of its banks was alleged to be insolvent.
→ A trustworthy stablecoin issuer will regularly publish proof of funds from an independent accountant.
1-for-1 backing
Some stablecoin projects might see it as convenient to maintain an extra “treasury” of stablecoins waiting to be backed. In a treasury model, a stablecoin will mint extra tokens before there are corresponding dollars in the bank. For example, Tether currently has around $2.5B tokens issued, but only about $1.9B in Total Assets. The remaining $600M of unbacked tokens sit in the “treasury wallet.”
This practice is dangerous because if the “treasury wallet” were to be compromised, the unbacked tokens would be let loose into the wild and undermine the value of all the other tokens. Treasuries also cause confusion with token holders. Uninformed readers might see the OmniExplorer for Tether and think they have all $2.5B in their bank account, when they really have less.
The core principle of 1-for-1 backing is that if someone held the full supply of the stablecoin, they could redeem it for the full value of the tokens.
→ Whether the stablecoin is backed by cash and cash equivalents, treasury bills, precious metals, or other assets, a trustworthy stablecoin issuer will ensure token-holders understand the assets that back the token’s value.
→ A trustworthy stablecoin issuer will maintain technical and legal enforcements that prevent the company from minting unbacked tokens.
Maintain Purchasing Power
Multiple stablecoin projects have given exclusive discounts to large OTC desks and market-makers, allowing them to buy the stablecoin for $0.99 and then resell it on the market. (Large trading desks and market-makers can confirm the existence of these discounts).
The problem with this type of discount is that the loss is passed to the rest of the token holders. Even if most users bought the stablecoin for $1.00, it will have less than $1.00 worth of purchasing power on the market.
If a trustworthy stablecoin issuer were to run a promotion, the issuer would take the financial loss of the promotion, instead of passing the loss onto token holders. Such a discount could include signed legal agreements and strong market monitoring, to ensure that the recipients of the discount could not sell the stablecoin for significantly beneath $1.00 and thus devalue the product.
→ A trustworthy stablecoin issuer will not issue promotions that destabilize the stablecoin’s market price.
Redeemability
Some stablecoin companies have created delays or barriers to redeeming their stablecoins for fiat. Bitfinex now charges a 1% fee for withdrawals over $1m, effectively blocking trading desks and market-makers from using Tether as a fiat proxy.
A trustworthy stablecoin is one where, if you held the entire market cap of the stablecoin, and legitimately tried to redeem it, the issuer would let you do it.
Of course, stablecoin issuers need to prevent attempts at money laundering. Some stablecoin projects may also have minimum redemption sizes due to technological capacity. The general principle is for stablecoin projects to not arbitrarily discourage redemptions in order to retain a higher market cap.
→ A trustworthy stablecoin issuer will not prevent or discourage legitimate redemptions.
Regulatory Compliance
Stablecoin issuers hold a responsibility to prevent their stablecoin from being used for illicit activities. The best way for stablecoin issuers to operate a long-term sustainable business is to enforce compliance standards through a thorough KYC/AML process.
→ A trustworthy stablecoin issuer will use the best technologies available to implement KYC/AML checks on clients who purchase or redeem tokens with fiat.
Now, let’s put together these takeaways to propose the first version of the Stablecoin Code of Ethics:
Start a Conversation
We invite all fiat-backed stablecoin projects to commit these principles. We welcome your feedback for revisions and additions. This post is the start of an ongoing dialogue. We expect to revise this Code of Ethics as the industry evolves.
We believe these principles aren’t in conflict with running a good business; they’re common-sense practices to build long-term trust with the people and businesses that rely on stablecoins.
Show Your Support
Creating new standards is an industry-wide effort.
→ If you think there is an important edit or addition to these principles and you want to contribute to their development, please write to us.
We are committed to upholding these principles with TrueUSD. Our next post describes how TrueUSD fulfills the Stablecoin Code of Ethics.
