I know very little about the family of projects known as “stablecoins” — cryptocoins designed to address the volatility of blue chip coins like Bitcoin. Mine is a state of willful ignorance, as there’s something about a coin designed to be price-stable, like Maker’s Dai, that has never sat right with me.
But that’s not a good enough reason to dismiss a project, so today I am going to do a deep dive into why I don’t like these projects.
My problem starts with the very name of the category, as it’s a bit deceiving. In economics, there is no such thing as stable, not on an absolute basis anyway. All financial value is relative, in the same way that in space, all motion is relative.
To demonstrate what I mean, consider the question “what has the value of Bitcoin done so far this year?” We can’t answer that question until we introduce a denominator. If we are measuring value in dollars, it has fallen significantly. But in Venezuelan Bolivars on the other hand, it’s done much better.
When we call something a “stablecoin,” what we really mean to say is “stable against fiat currency.” That’s an important distinction, and also a clue as to why these products were invented in the first place. No matter how great the underlying blockchain technology of cryptocoins like Bitcoin and Litecoin, their function as a medium of exchange has been hampered by their volatility.
The problem is made even worse by the fact that not only are the coins volatile against fiat money like the Dollar, but they are even more volatile against each other. If you’ve owned Litecoin over the past year, your coins have either halved or doubled in value — depending on whether you are comparing against dollars or bitcoins. You can’t use a currency like that in your day to day affairs.
Stablecoins are meant to solve this problem by combining the decentralized infrastructure and transparency of a blockchain with the more palatable price volatility of fiat money. A more accurate name for them would be “Dollar-pegged coins.” Here’s a description of Dai from its website:
“Dai is a cryptocurrency that is price stabilized against the value of the U.S. Dollar”
A SmartCoin is a cryptocurrency whose value is pegged to that of another asset, such as the US Dollar or gold.
So far, so good. I’ve already written about how I think the Dollar might be the next killer app for blockchain tech. So why don’t I like the projects listed above? Because they introduce complicated mechanisms to try to make a cryptocoin look and act like the Dollar. But you know what else looks and acts like the Dollar? The Dollar.
Tokenizing actual dollars is a simple process. First you put a bunch of them in a bank account as collateral, then issue tokens on a blockchain corresponding to each one. As long users are confident that they could redeem their tokens for actual dollars, the value stays at close to $1.
Creating stablecoins that are pegged to the Dollar, on the other hand, is far more complicated. Here again is Bitshares:
SmartCoins implement the concept of a collateralized loan and offer it on the blockchain. For the purpose of this discussion, we will assume that the long side of the contract is BitUSD and that the backing collateral is BTS (the BitShares core asset). To achieve this, SmartCoins use the following set of market rules:
1. Anyone with BitUSD can settle their position within an hour at the feed price.
2. The least collateralized short positions are used to settle the position.
3. The price feed is the median of many sources that are updated at least once per hour.
4. Short positions never expire, except by hitting the maintenance collateral limit, or being force-settled as the least collateralized at the time of forced settlement (see point 2).
Good luck getting people to use that coin to buy coffee.
Critics of tokenized fiat money argue that its simpler approach creates two centralized sources of failure, one in the bank that holds the collateral and another in the tokenizing entity. They are absolutely right, as we’ve seen time and again with Tether. But risk, just like value, is a relative concept. The question is not whether tokenizing fiat money in a centralized manner is risky. It’s whether doing so is more risky than a far more complicated decentralized approach.
I would argue not, because we are talking about money.
Complicated structured products are an important part of traditional finance, and the stablecoins mentioned above remind me of them. I mean that as a compliment, because both Dai and BitUSD strike me as sophisticated products created by intelligent people. But therein lies the problem.
Money is not supposed to be sophisticated or intelligent. It’s mostly a made-up thing, a myth that we all agree to subscribe to, because it serves a useful function. The US Dollar is not the world’s reserve currency because the Federal Reserve manages its supply using a modified Taylor Rule tied to the CPI. It’s the world’s reserve currency because ever since winning the second world war, America has loomed large in the global imagination, not to mention in trade, finance and pop culture.
The other reason people use the Dollar is because compared to other currencies, it is very stable. A lot of that stability stems from the fact that people expect it to be stable, and price volatility (or the lack thereof) is a self-fulfilling prophecy. That doesn’t mean that a central authority can’t destabilize the Dollar eventually, and if history is any guide, it’s only a matter of time until they do. But for now, its value is stable and its acceptance is ubiquitous, making it a great candidate for a global digital medium of exchange.
So instead of trying to reinvent the Dollar, let’s just tokenize it.
The markets, for what it’s worth, seem to agree with that conclusion. I find it telling that despite all of the controversy surrounding Tether, the market cap of its tokenized dollars is currently 20x more than the highest valued stablecoin. If we look at acceptance at crypto exchanges, the gap is even bigger. We can assume that a more trustworthy version of the same product (be it from Circle or these guys) will be even more popular.
That’s not to say that the various stablecoin projects out there are useless. I think the kind of decentralized structured products they empower might someday revolutionize institutional finance and the global derivatives market. But I wouldn’t be surprised if the first generation of those products still use tokenized dollars to settle their transactions. Money is a myth, and the arc of a popular myth is longer than any technological cycle.