Stanford economist John Taylor, a former Republican Treasury official and once a favourite to succeed Janet Yellen as chair of the Federal Reserve, is probably best-known for the “Taylor rule”. This is essentially a guideline for how much central banks should adjust interest rates in response to changes in economic conditions, which suggests monetary policy should be more systematic, and less sensitive to politics and other outside pressures.
But now, Mr Taylor has got into crypto. Sigh. Yawn. Oh gosh not another one, etc.
No but wait! This isn’t the lambo-flaunting, money-stealing, nose-diving kind of crypto you might be used to. This is stable crypto.
Stablecoins are a fast-emerging part of the fast-emerging world of cryptocurrency. If normal crypto is fist-pumping electronic music, these coins are slow radio. Their basic premise is that although cryptocurrencies are too volatile to be used as currency, they do have some potential advantages like fast international transfers, being available to anyone with an internet connection, and providing an alternative to people in countries like Venezuela, whose own currencies are being eroded away by runaway inflation. So rather than floating freely on the market and being subject to the wild price swings of other cryptos, stablecoins are pegged to a stable central-bank-issued currency — the dollar, usually.
Some stablecoins, like the “USD Coin” that crypto firm Circle will be launching soon, say they are backed one-for-one by the mighty US dollar. The most famous of these is Tether, though many worry that it does not have the dollars it says it does and that Tethers are instead being produced out of thin air and pumped into the system to prop up the prices of other cryptocurrencies. (Tether produced a lawyer’s report last week to prove they did have the dollars to back the Tethers, but seeing as this wasn’t actually an audit — it was an “account snapshot” — and it wasn’t even done by accountants, many people were not convinced.)
Basis, however, does not claim to have any such reserves, despite receiving $133m in investment from a bunch of big name VC investors such as Bain Capital Ventures and Andreesen Horowitz. Instead Basis, “a stable cryptocurrency with an algorithmic central bank”, uses a complex market mechanism borrowed from traditional financial markets to ensure stability. That, in turn, is what gives it its value, we are told.
Basis founder Nader al-Naji, a Princeton graduate and former software engineer at Google, told us:
At a high level, by marrying traditional monetary theory with cryptocurrency, Basis is trying to deliver all the benefits of crypto but without the volatility.
The website is all simplicity and light (a contrast to the garish colours, celebrity endorsements and hyperbole that the SEC parodied in truly exemplary fashion last month):
Here’s a bit more explanation, from the Basis white paper:
While much cryptocurrency research has been dedicated to technical topics such as transaction throughput and smart contracts, almost no attention in comparison has been paid to improving price stability, a problem we believe to be a much bigger obstacle to the mass adoption of cryptocurrencies as a medium of exchange.
…The Basis protocol accomplishes this by algorithmically adjusting the supply of Basis tokens in response to changes in, for example, the Basis-USD exchange rate. This implements a monetary policy similar to that executed by central banks around the world, except it operates as a decentralized, protocol-enforced algorithm, without the need for direct human judgment. For this reason, Basis can be understood as implementing an algorithmic central bank.
By this stage, it should have become clearer why Mr Taylor, advocate of rules-based monetary policy and critic of unconventional policy such as quantitative easing, became an adviser to the project.
Mr Taylor told us (emphasis ours):
I do think that monetary policy has not always been very successful. To some extent this is because people have not always made the adjustments in time — there are political pressures, or they’ve delayed it, or something’s prevented the central bank from moving. This [Basis] is a great improvement on that.
The stability is so important – that’s what’s so, just, beautiful, and intriguing about this currency. It will get that stability, and it’s really what we’ve been searching for forever — to have a stable, reliable medium of exchange.
It all sounds quite, well, beautiful, right? And what is it backed by, again? Mr Taylor, again:
It’s not backed by anything other than the fact this is stable.
Wow, OK. But let’s look at how it actually intends to work. Because it is not backed by dollars, the way Basis plans to maintain its stability is by executing open market operations. In other contexts, that means the buying and selling of securities in the open market, in order to produce an expansion or contraction of the amount of money in the system. In Basis’s case, it means an algorithm buys and sells what it calls “Basis bonds” — on the blockchain of course — in response to changes in demand.
Here’s Mr al-Naji:
When the price is below a dollar, the protocol automatically automatically sells the “bond token” on the blockchain for Basis. So the bond tokens go into circulation and Basis goes out of circulation, and that’s how the supply of Basis contracts. It’s almost exactly like an open-market operation from a central bank.
Mr al-Naji says there’s an incentive to become involved in the market because of the arbitrage opportunity:
It allows people to essentially buy a bond for less than par value, which is what traditional monetary system does… When Basis is selling these bond tokens, their par value is 1 because they (the bondholders) are eventually going to get paid back one full Basis. But the market participants can buy them for less than one full Basis. That effectively contracts the supply and provides an incentive for people to buy Basis on the market.
Basis is trying to create promises to pay, just like banks do. But the difference is Basis is doing this without anything to guarantee those promises like, say, the balance-sheet of a sovereign state.
University of the West of England macro-finance professor Daniela Gabor, whose work focuses on shadow banking and transnational banking, told us the following:
The moneyness of a bank deposit means I can go to my bank any time and say that for every pound I’ve put in there you have to give me back a pound of cash… (but) Basis is creating promises to pay out of nothing. The question is: why would these promises to pay have moneyness? Why would I trust them that whatever I want to switch back into state money, I can?
…What the bond token is doing is transferring the responsibility of par convertibility – it’s kicking it down the line – onto the bondholder in that process.
Nicholas Weaver, Berkeley computer science professor and blockchain critic pointed out to us that there didn’t seem to be much thought given to the security of the system — blockchain-based systems, like any internet-based computer systems, are prone to attack:
It reads like classic computer programming utopian nonsense. It waves away the notion of attacks on the system from an economic perspective.
He also pointed out that it was going to be tricky for Basis to try to convince the SEC that “Basis bond tokens” were not securities.
On that, Basis told us:
We haven’t yet publicised our regulatory approach but we are working with reputable external and internal counsel to do the regulatory analysis and stay on top of any developments so that we can design Basis to be both compliant and able to achieve its mission.
Hmm. OK. And what about making some money for Basis’s investors, we ask? Mr al-Naji, again:
It’s very important to us that we comply with regulatory requirements so I’d avoid focusing on the commercial aspects of Basis. But as a general answer, our design goal is to have participants in the system share in expansions of Basis supply when the Blockchain decides an expansion of supply is needed. You can check out the White Paper on our website for more information on this design as well.
Ah, sorry, OK, let’s not focus on the commercial aspects of a currency that’s received $133m in investment before it’s even launched. We’ll check out the white paper.
Has bitcoin come to the end of its Tether? – FT Alphaville
Crypto tethers as the new eurodollars – FT Alphaville
Treasury sector alarm over ‘Taylor rule’ looks misplaced – FT The “academic’s cryptocurrency” is an elegant waste of time – FT Alphaville
Buy SEC tokens! Now! – FT Alphaville