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AMA Recap: Are stablecoins dead?

The countdown is on.

After more than 10 years, the blockchain industry’s players — big and small — continue to struggle to achieve real-world adoption. Nevertheless, one of the industry’s few bright spots has been stablecoins.

Today, the total stablecoin market exceeds USD 11.15 billion. Leading stablecoins, such as USDT, have even surpassed blockchain industry stalwarts like XRP in terms of market capitalization. Yet, the usefulness of existing stablecoin solutions, beyond serving as a kind of parking lot for cryptocurrency investments during times of high market volatility, is still up for debate. There is little doubt, however, that stablecoins are easier for traditional industry players to conceptualize.

Central banks around the world are actively exploring issuing their own national digital currencies; projects like Facebook’s Libra have gained widespread mainstream media coverage; and top exchanges are increasingly issuing their own stablecoins for use within their ecosystems.

Stablecoins, if nothing else, provide a bridge between new and old sensibilities. But real, value-added stablecoin use cases remain few and far between. The issue is that existing stablecoin solutions suffer from at least one of the following problems:

This begs the questions: why haven’t stablecoins and stablecoin-like solutions yet been able to fulfill the promise of blockchain technology? Will stablecoins be able to elevate DeFi beyond an industry buzzword? And how can stablecoins bridge the gap between blockchain technology and real-world business models?

To answer these questions — and more! — Velo Labs teamed up with leading Chinese blockchain news outlet BBNews for an Ask-Me-Anything (AMA) focused on the past, present and future of stablecoins.

The AMA, held on July 20th, 2020, attracted more than 1000 blockchain enthusiasts. Velo Labs, represented by Chinese Community Manager, Phil Ren, was joined by dForce founder Yang Mindao and Bixin Vice President Frank Ling. Below is an excerpt of the AMA highlighting Phil Ren’s thoughts and answers.

Phil Ren: The primary issue that these three major financial regulation institutions are worried about is financial stability. They essentially worry that the emergence of stablecoins may result in excess monetary activity and risk that could lead to instability in the international monetary system. In an extreme case, resulting volatility could lead to a full-blown financial crisis.

These worries are not unfounded. An example of this extreme case playing out is the 2007–2008 global financial crisis, which stemmed from excessive lending in the US real-estate market. This did, in fact, lead to a crisis in global financial liquidity. Looking back, I think there are three major lessons we can learn that apply to today’s stablecoin market.

Therefore, as long as a blockchain protocol prioritizes these three lessons in its design and development processes, it is likely to be accepted and embraced by the mainstream market and existing regulatory bodies as these kinds of blockchain protocols will add value to the system rather than bring about institutional instability and unpredictability.

As an aside, we designed the Velo Protocol to have regulatory compliance in its DNA. The Velo Ecosystem only accepts accredited participants, and it is targeting problems that the existing financial system has yet to solve. For example, the remittance problem currently hurting the unbanked and underbanked populations of the world.

Phil Ren: Stablecoins were originally created to help cryptocurrency investors and traders purchase cryptocurrencies since, in a lot of regions, there are no direct channels or on-ramps between fiat and cryptocurrencies.

However, as the advantages of blockchain technology become more and more apparent — in that blockchain is a comparatively efficient and transparent technology — stablecoins have ventured into additional financial segments such as international transfers, lending, payments, and even derivatives. In each of these new areas, we have seen an explosion in the number of applications over the past two years. Recently, the industry has been referring to these as Decentralized Finance (DeFi). It seems that people are increasingly finding that financial solutions using blockchain technology are easier to use and are more trustworthy.

In my opinion, I don’t think that stablecoins contradict the concept of fiat currencies. Rather, stablecoins complement fiat currencies. Since stablecoins are usually pegged 1:1 in value to their corresponding fiat currencies, they tend to serve similar functions and provide similar services. However, as I mentioned, because stablecoins leverage the comparatively more efficient and effective blockchain technological solutions, they are able to achieve cost savings beyond what the traditional monetary value transfer systems can achieve, and can therefore take advantage of opportunities in markets that were once deemed too costly for traditional service providers to enter. For example, in the international remittance market, a lot of unbanked and underbanked migrant workers are unable to engage in cross-border remittance because it is too costly for them to send money using the traditional system. With blockchain technology, the cost can be significantly lowered, thereby offering remittance to a market previously unreachable by the traditional remittance system.

Phil Ren: To be honest, stablecoin projects have not historically abided by a set of formal regulations. For example, much has been said about Tether refusal to disclose in which bank they stored their monetary collateral out of fear that their accounts would be frozen. Tether’s initial refusal to comply invited a non-stop barrage of federal investigations. As a result, Tether has become increasingly collaborative with federal regulators. Recently, Tether worked with federal regulators to freeze a number of wallet addresses exhibiting questionable behaviour.

I think that, both logically and realistically, stablecoins will all eventually need to comply with regulations. This is because, stablecoins are complementary to fiat currencies. They have similar functions and they serve similar markets. As stablecoins become more mainstream, they will need to embrace regulatory compliance in order to be accepted by the authorities regulating the mainstream markets. These projects will need to prove that they are safe to be used by the general public.

Therefore, regulation will not hinder the development of the stablecoin industry. Rather, regulation will result in a healthier industry. For stablecoins, the choice really boils down to proactively embracing regulatory compliance vs being forced into a regulated existence.

Phil Ren: Naturally, I think that each type of stablecoin has its advantages and disadvantages.

Centralized stablecoins leverage blockchain technology yet their governance and financial systems are centralized. In other words, the project’s owner controls the monetary supply of the tokens and can issue tokens at their own discretion. The centralized model is very similar to the traditional monetary supply system, in that a central authority is in charge.

The advantage of such a model is that the implementation of blockchain technology allows for greater technical efficiency. Things, however, get more interesting when considering the a centralized stablecoin’s governance system. If a centralized project decides to comply with regulations — as is the case with projects like PAX and GUSD — then it is more reliable to use. However, this strict compliance to regulatory compliance may result in the stablecoin’s restricted circulation. Conversely, if a project is lacking in terms of regulatory compliance — such as USDT — there is little restricting its circulation but the risks of regulatory probes increases exponentially. These kinds of projects have significant risks since its issuers are not held accountable for the collateral used to back the issuance of their stablecoins.

Things also get interesting when looking at decentralized stablecoins. Decentralized models leverage both blockchain technology and decentralized governance system. In decentralized models, users usually stake cryptocurrencies as collateral and then issue fiat-pegged stablecoins. Decentralized projects, such as DAI, are more transparent than their centralized counterparts since they show exactly what is being collateralized for every issued stablecoin due to the fact that all transactions are issued using a transparent smart contract system. However, these projects often lack sufficient risk management mechanisms to protect their users. Since decentralized projects are often open to everyone, they often attract at-risk users who do not fully understand the risks associated with using and engaging with stablecoin issuance mechanisms.

In my opinion, a good model is one that combines the transparency of a decentralized system with a more traditional governance system designed to ensure that its participants are both informed and protected. Only by combining an efficient and transparent system with an alliance of accredited participants can we ensure a highly effective, high-value model.

Phil Ren: Over the years, we have seen the stablecoin market grow at an incredible pace. This rapid growth started with Tether’s USDT, then continued with the emergence of all sorts of stablecoin variations. Going forward, the market for stablecoins will continue to grow as will the need for such products. Day trading, cross-border transfers, lending and payment solutions will all benefit from stablecoins.

One of the reasons that stablecoins continue to expand into more financial service segments is due to stablecoins’ technical advantage over existing digital payment systems. Stablecoins are easier to transfer and transaction records are more reliable due to the fact that they leverage blockchain technology.

On the other hand, stablecoins function in a similar way to fiat currencies. When users transact with stablecoins, they are essentially using a medium of exchange that assumes the value of fiat currencies in its transaction system. I believe that, in the future, for any stablecoin to flourish in the market, it will need to be a complement to the mainstream financial systems instead of acting as an opposing force. More specifically, I think a “mainstream” stablecoin will exhibit three core traits: it will be compliant, it will add value, and it will solve real-world problems.

By compliant, I mean that the product needs to embrace regulations and follow the regulatory compliance rules in the regions in which is wishes to operate.

By adding value, I mean that the product needs to add value to the market it services. It needs to make the pie bigger, rather than trying to pry business away from existing players.

And by solving real-world problems, I mean that a successful product needs to solve true issues that are plaguing the world. For example, the Velo protocol is helping to solve remittance issues that have long hurt the unbanked and underbanked populations of Southeast Asia.

Overall, I think that any stablecoin product that exhibits these three core traits will have a real chance to break out of the “cryptosphere” and resonate in the mainstream market.

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The Velo Protocol is a blockchain financial protocol enabling digital credit issuance and borderless asset transfer for businesses using a smart contract system. The Velo Protocol can issue digital credits pegged to any fiat currency.

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Velo Protocol

A blockchain financial protocol enabling digital credit issuance and borderless asset transfers for businesses using a smart contract system