Originally posted 25 May 2019. Reposted during holidays to give our experts a break.
TLDR. When Vitalik Buterin and Balaji Srinavasan were asked whether certain trends were either underrated or overrated, they both said that StableCoins were underrated. This post is my explanation of why I think they are right. Yet we have already seen some high profile StableCoins fail, which is why the headline also refers to why StableCoins are also so hard to get right.
In the image above you see the usual path to a currency – from Store of Value to Medium Of Exchange to Unit Of Account. Bitcoin could be all three but today faces a volatility chasm, with wild bull and bear markets. A StableCoin is designed from the start to be all three.
Today Bitcoin is a speculative Store of Value (the digital gold thesis). I am on the record saying that Bitcoin has more upside than downside and have been a buyer, but it is certainly a speculative bet. Even though it is speculative, Bitcoin has some credibility as a Store of Value. However Bitcoin is weak as a Medium Of Exchange (there is not much you can buy directly in Bitcoin) and Bitcoin is not credible at all as a Unit Of Account. You will know when Bitcoin becomes a Unit Of Account – we stop referring to how much something costs in Fiat currency and only refer to the cost in Bitcoin or Satoshi units.
Watch Vitalik Buterin (Ethereum) and Balaji Srinavasan (Coinbase and A16V) talk about StableCoins around minute 38
This update to The Blockchain Economy digital book covers:
- Mixing SpeculativeCoin and StableCoin in one venture does not work
- StableCoin for JP Morgan, Facebook & Samsung is just the tip of the iceberg
- Why a StableCoin has to be multi-currency basket
- Don’t bet against Government backed CBDC.
- Low volatility is essential for Cross Border payment rails
- Bitcoin as a Medium Of Exchange faces hurdles that will take a long time to overcome
- You cannot manufacture a stable result out of unstable/volatile base
- Audit heavy/ tech lite is simple key to trust in redemption
- StableCoin can be a currency for passionate global communities
- StableCoin can be bridge into crypto for conservative adopters
- Context & References
Mixing SpeculativeCoin and StableCoin in one venture does not work
We call them StableCoin to differentiate from coins/cryptocurrencies that are speculative. So I coined (sic) the word SpeculativeCoin.
SpeculativeCoins have benefited from a great business model, defined as Tokenomics (funding via coins that you sell into a rising price). The idea got discredited in the ICO hype and got nailed by the SEC (details here).
Ripple has been masterful at using Tokenomics to boost XRP. Whether that means XRP has value is more debatable, but there is no question that Ripple has done well with this model. It is debatable how many Altcoins will do well, but what is absolutely certain is that you cannot mix SpeculativeCoin and StableCoin in one venture.
Speculative Coin/Tokenomics might work. StableCoin might work. An investor might mix SpeculativeCoins and StableCoins into a portfolio just like you might have Facebook and Exxon Mobil in the same portfolio. However, the two models are totally different. It would be like combining Facebook and Exxon Mobil in the same operating business.
StableCoin for JP Morgan, Facebook & Samsung is just the tip of the iceberg
It is hard to keep up with the flurry of PR from big companies offering their own branded StableCoins. Without trying too hard to stretch the memory banks, we have seen StableCoins launched by JP Morgan, Facebook & Samsung. Other big banks, social media networks and consumer electronics companies will soon have to issue one to compete. Soon we will have a StableCoin for each Global 2000 corporate and then it may move to SME.
When every company has their own StableCoin, it will add about as much competitive advantage as having your own .com address.
Why a StableCoin has to be multi-currency basket
A single Fiat currency StableCoin, whether USD or EUR or CHF or any other reasonably stable Fiat currency is not good enough for two reasons, one of which is critical:
– a multi-currency basket is more stable than any single Fiat currency. Even if a Fiat currency has been stable for a long time, smart investors don’t like betting that politicians won’t do something stupid in future. Printing money is a pretty big temptation!
– a single Fiat currency could be seen as a threat by the nation state that issued that currency. Although governments cannot shut down Bitcoin or Ethereum (for more, read this chapter in The Blockchain Economy), they have more control when it comes to a single Fiat currency StableCoin. This is an existential threat to a StableCoin venture pegged to a single Fiat currency. As the news of Basis shutting down shows, this is not just a theoretical risk. Basis shut down, despite raising over $100m from top tier investors, because of regulatory pressure.
Don’t bet against Government backed CBDC.
CBDC = Central Bank Digital Currency. A CBDC cuts out the FX Interbank market but not the Central Bank. It is a more efficient Fiat currency; still Fiat but faster and more efficient. Governments that are frustrated by their ability to shut down Bitcoin (because it is decentralised and there is no Bitcoin company) will not hesitate to shut down any threats that are easy to shut down.
That is why a single Fiat currency, which could be seen as a threat by the nation state that issued that currency, faces existential risk from Governments.
Low volatility is essential for Cross Border payment rails
“Use case # 3 is using Bitcoin as an invisible interim store of value. Neither sender nor receiver cares about Bitcoin. If you wanted an interim store of value for this purpose, the last thing you would invent is Bitcoin. You would create something that was almost a mirror image of Bitcoin:
- Had the lowest possible volatility against the major Fiat Currencies.
- Was not perceived as a threat by the Governments that issue those Fiat Currencies.”
Look at the 10×3 problem. Imagine getting paid for a product with a 10% margin and in the 10 minutes to settle on-chain, the price declines by 10%. You just lost money on that sale, even if fees are zero.
Bitcoin as a global Medium Of Exchange faces hurdles that will take a long time to overcome
We may pay for most our purchases with Bitcoin at some point in the future. The problem is that may be so far in the future that we a get our space flight to Mars before Bitcoin becomes a global Medium Of Exchange.
Our theory is that it will happen first via the excluded in countries suffering a currency crisis (for more, read this chapter in The Blockchain Economy). So we may see local networks where Bitcoin crosses the chasm to become a Medium Of Exchange (for example in Venezuela). Then it may replicate in other failed states who lost control of their currency.
For Bitcoin as a Medium Of Exchange to cross the chasm in the developed world, we will need a wave of startups to create services to meet needs that consumers are not even aware of yet.
Both will take time.
These cryptocurrency derivative solutions use algorithms to match supply & demand of an existing volatile cryptocurrency such as ETH to create a cryptocurrency derivative that is stable.
Can you manufacture a stable result out of unstable/volatile base?
The idea sounds a bit like creating Triple A mortgage bonds out of junk loans – and we know how well that ended in 2008! Some well funded startups are working on this approach, so we shall wait and see if it works.
Audit heavy/ tech lite is simple key to trust in redemption
These ventures match each Stablecoin purchased with a corresponding deposit in a Fiat bank account. The Fiat bank accounts are audited so that investors can be confident that the Stablecoin is a real asset.
If there is no tech solution that byepasses the Legacy Finance economy, the best solution may be the audit heavy/ tech lite approach that we define in this chapter of The Blockchain Economy book:
“Fiat collateralised (Fiat deposits held in custody). This is the most popular and easy to understand and used by most StableCoins. For example, Tether/USDT pegs to the US Dollar via reserves held in custody. So if you buy $1 of USDT, you are told that it is backed by $1 of US Dollar held in a bank. This obviously requires some confidence that the StableCoin operator really does have the assets properly custodized; there has been serious concern whether Tether/USDT was doing this. Confidence measures include an audit by a reputable firm. StableCoins will increasingly fall under regulatory scrutiny as they are deposit taking and need at least AML/KYC processes. This model has been described as “audit heavy/tech light”. It is operationally complex, because you need all the Legacy Finance relationships; bridging the worlds of Crypto and Regulated Banks is not easy.”
StableCoin can be a currency for passionate global communities
We live in a world where more people are members of Facebook than are citizens of even huge population countries and where we often have as much in common with “tribes” across the globe than we do with our physically close neighbours. People who are passionate about something (diet, fashion, religion, whatever) want to find others like them when they travel and when they want to give cash to that person, a multi fiat StableCoin can be trusted by both parties.
StableCoin can be bridge into crypto for conservative adopters
On a panel at a conference, I told the panelist next to me (a senior banker) that I was a Blockchain and Bitcoin bull. The banker asked me if that meant that I was an anarchist. I laughed and said “look at me, I have grey hair and wear a suit, how can I possibly be an anarchist?” The point is that when you leave the cryptosphere and talk to mainstream business people and investors, they look for something that feels more normal and less mind bending than Bitcoin – like StableCoins.
Context & References
I have no positions or commercial relationships with the companies or people mentioned. I am not receiving compensation for this post.
Subscribe by email to join the 25,000 other Fintech leaders who read our research daily to stay ahead of the curve. Check out our advisory services (how we pay for this free original research).