The myth of money perpetrates every level of our day-to-day lives and is perhaps best described by historian Yuval Harari: “Money is the most universal and most efficient system of mutual trust ever devised. Even people who do not believe in the same god or obey the same king are more than willing to use the same money.” We trust that someone will accept our money in exchange for goods and services almost anywhere we go.
Modern society relies on banks and governments to enforce (or perpetuate) this myth, which is being questioned more and more frequently since the 2008 financial crisis shook our faith in these institutions. The next evolution of financial markets aims to use blockchain to reconstruct this myth and place faith in technology instead of centralized institutions.
Today, with over 120 projects on the market, it seems that stablecoins may lead the mass adoption of cryptocurrency payments for which the industry ‘veterans’ have been waiting. As we adjust to a new norm of cryptographic finance, the following is an introduction to the intricate field of stablecoins.
What are Stablecoins?
Like other cryptocurrencies, stablecoins aim to become global, fiat-free money that is programmatically issued and tracked with the use of blockchain technology. Stablecoins fall into the category of payment tokens, whose main purposes are store of value, medium of exchange, or unit of account. Unlike other cryptocurrencies, such as bitcoin and ether, stablecoins by design aim to achieve stability and decrease the volatility that is frequently associated with the cryptocurrency markets.
The main benefits that stablecoins strive to create are price stability, scalability, privacy, decentralization and redeemability.
Most stablecoins fall into one of the following three buckets:
Fiat-collateralized stablecoins are backed by an existing currency such as the USD. The issuing company holds assets in a bank account or vault (or works with a third party provider that does so on their behalf). The coins represent a claim on the underlying assets. This works similarly in cases where the coin is backed by gold or another precious metal.
These are the easiest to understand for those new to crypto, and remain the most popular onboarding tool into the cryptocurrency world. These stablecoins are simple, elegant and more easily trusted by retail consumers than other cryptocurrencies. But, buyer beware – the coins are issued by centralized entities with their own governance protocols and, in the case of full custody integration, can be prone to fraud. Additionally, not all fiat currencies are stable, as the fiat that underlies them, may not be stable itself. For example, one has to have faith in the US Dollar to hold a USD backed stablecoin. Notable examples of fiat-backed stablecoins include tether, TrueUSD, USDCoin and Gemini Dollar.
Gemini Dollar is the first regulated stablecoin. By providing a bridge between the conventional fiat banking system and crypto markets, Gemini Dollar enables investors to access institutional products on the blockchain without the price volatility associated with traditional cryptocurrencies,” says Sterling Witzke, partner at Winklevoss Capital.
Crypto-collateralized stablecoins are backed by a mix of other decentralized crypto-assets. The benefit of this method is that it is decentralized and is therefore not vulnerable to a central point of failure. The downfall is that despite their mix of assets designed to reduce volatility, in today’s uncertain bear market, any mix of crypto assets will be deemed unstable. The most notable example is MakerDAI, which, despite the past year of market volatility, has proven stable in the short term.
MakerDAI maintained its peg through 2018 in spite of an 80% drop in the price of ether as its only source of collateral. It will be interesting to see how DAI performs once it adds new collateral types such as security tokens and even fiat-collateralized stablecoins,” says Marc Weinstein, principal at Wave Financial.
Non-collateralized stablecoins maintain stability using an algorithm, meaning the coins are not actually backed by real-world assets. Instead, trust in the system is reliant on the expectation that the coins will gain a certain amount of future value (similar to bitcoin). These models are generally created with two tokens: the first is a stablecoin, and the second is akin to a bond promising income if the stablecoin rises in price. By purchasing the bond with the stablecoin, supply is decreased. These are the most innovative of stablecoins and also the most difficult to create successfully. A notable example includes the now-defunct Basis project.
Hybrids are being created to take advantage of both fiat and crypto-collateralized models, such as Reserve and Carbon.
Why are stablecoins important?
The vision for stablecoins is larger than that of bitcoin. The total addressable market for stablecoins is essentially all of the money in the world, or approximately $90 trillion. As a result, they are frequently dubbed as the ‘holy grail’ of financial technology. Stablecoins promise an on-ramp into the crypto world that a retail user can easily trust and understand, paving the way for wider acceptance and adoption of programmable money and securities. A successful stablecoin may challenge the legitimacy of the current myth of money backed by weak governments around the world.
What are the major use cases?
Currently, the most common use of stablecoins is for crypto traders to move between investment positions seamlessly and create leveraged positions, without added volatility. For stablecoins to be accepted as a viable alternative to fiat currencies, however, they must first intersect and integrate into our current financial infrastructure. Various use cases have been proposed, including mobile app payments, alternative currencies in emerging markets and global payment systems.
Three projects currently coming to market exhibit these use cases perfectly.
In 2014, Facebook hired former PayPal president David Marcus, who also happens to be an advisor to Coinbase, to run its Messenger app. Subsequently, last year Marcus became head of the blockchain group and hired 40 members to his new team. In December, the company announced a WhatsApp stablecoin integration in the works, with a focus on India. In this brilliant move, Facebook finally gave Telegram’s highly anticipated coin a competitor by promising to incorporate its own coin into the WhatsApp messenger. With over 200 million users in a market with over $69 billion in remittances, the potential impact of this new technology is massive: an entire ecosystem of direct-to-consumer transactions taking place outside of the current banking and payment infrastructure.
In 2018, 16 countries around the world had more than 20% annual inflation year over year. Most notable of which is Venezuela, which has suffered 2 million percent inflation in the last year. Enter Reserve to solve this specific problem. “We’re building something that will provide economic stability to parts of the world where currencies are losing their value at alarming rates,” says cofounder Miguel Morel.
The Reserve Protocol uses a hybrid system to autonomously implement an automated exchange-rate peg between the Reserve token and the US dollar through the use of its Vault, which holds a basket of tokenized real world assets to collateralize the Reserve token with 1:1 backing. The company is backed by Coinbase, Peter Thiel, and Sam Altman.
In 2017, J.P. Morgan Chase CEO Jamie Dimon famously dubbed bitcoin as “fraud,” causing a news frenzy in financial circles. Although the institution maintained its own optionality by saying it saw potential for blockchain technology, somewhat surprisingly, just last month J.P. Morgan became the first U.S. bank to create a fiat-backed stablecoin. The lender that moves more than $6 trillion around the world daily is taking advantage of the technology to facilitate the instantaneous transfer of payments between institutional accounts. JPM Coin promises to set a new standard for global transfers. Although institutional adoption of blockchain is a positive signal to the market, it is also worrisome, as it could ensure that the ‘myth of money’ will continue to be controlled by large incumbent institutions.
JPM Coin is an evolution of the antiquated and wholly inadequate Swift payment system. Using a private, permissioned blockchain, as JPM is doing, is a logical choice of technology to move international bank-to-bank payments into the 21st century. JPM Coin is more or less a centralized wholesale stablecoin, and has none of the revolutionary characteristics of bitcoin- it is simply upgrading Wall Street’s back office,” says Travis Kling, CIO at Ikigai Asset Management.
Digital Securities Use Case
The final use case, which is seldom discussed, is one of coupon and dividend payments in the up and coming digital securities space. In traditional markets, dividends and coupons are usually paid semi-annually to decrease the actual cost of payment. Between doing the math, checking the investor’s address, paying for the cost of mailing and the printing of the check, the entire distribution process can cost $3 to $5 per payment. The problem with this number is that retail investors with modest positions often receive checks of less than $5, which they quickly throw in the trash rather than walking over to a bank. Imagine a world where you could receive your coupon payments in real time via a stablecoin directly into your smartphone’s digital wallet, ready to be spent as you wish? Although the infrastructure for this is not yet built, we can expect to see it on the market in the next 6 to 12 months.
Stablecoins have a realistic shot at becoming the ‘killer-app’ that crypto has been waiting for. Nevertheless, before full adoption is reached, stablecoin developers will need to address concerns over scalability, price-fixing, privacy, and backlash from governments. In the meantime, decentralists will need to be patient in the hopes that someday we will reach a point where digital currencies enjoy the same collective trust that traditional fiat does today. Then, and only then, will the myth of money finally be meaningfully challenged.