Stablecoins and Monetary Sovereignty
Stablecoins are crypto tokens that are pegged to the price of fiat currencies. The most common denominated currency is the US Dollar (cryptodollars), but many other currencies are used such as the Euro, S. Korean Won, Pound etc. A stablecoin’s purpose is to maintain price stability and in turn its purchasing power. The idea behind this is to have a blockchain asset that’s not used for speculative or investment means, but to have something protecting one against market volatility. It is a way for investors to reduce their exposure of their portfolio without having to move their assets off the blockchain.
The US Dollar has historically always had high demand globally. It has been the world's reserve currency for decades. Institutions and nations alike want dollar exposure.? Particularly emerging economies. However, there’s limited supply and thus a crunch at times. In the 1960s, to abate this, Eurodollars were formed due to the Fed's inability to keep up with demand. Eurodollars are US dollar accounting entries that are used to settle cash flows between various actors outside the banking system linked to the Fed. Eurodollars are not real dollars. They are dollars kept in foreign bank accounts or dollar aggregates. Thus, Eurodollars are not answerable to US banking regulations. International actors, banks and corporations are reliant on dealer markets and shadow banks. Much of the Eurodollar activity is conducted by shadow banking. Actors conduct bank-like activities outside of the traditional banking sector, largely in the form of lending. This acts as a provision for eurodollar funding to uphold liquidity and service debt. Through shadow banks institutions can pledge capital as collateral in exchange for Eurodollars. In 2016 the Eurodollar market size was $14 trillion.
The crypto alternative to the Eurodollar would be cryptodollars in the form of stablecoins. These cryptodollars fill the same function as Eurodollars but are more transparent, auditable and censorship resistant - due to the blockchain technology they are built on. It can be traded without any downtime. Cryptodollars will be an upgrade to Eurodollars and more widely available. Now private individuals can get exposure to dollars and not just institutions and states. These stablecoins (cryptodollars) will usher in a new economy. There are different gradients to dollar exposure, from most permissionless to the purest form of money.
There exist many variations of stablecoins. In general, stablecoin projects can be examined by the degree of 1.decentralisation, 2.price stability and 3.capital efficiency. Multicoin Capital describes this as a trilemma, where most stablecoins are satisfactory in two out of the three. There is always a tradeoff, with, at least, one of the three dimensions being sacrificed. The method of issuance of a stablecoin reveals to us how centralised it is. Some issuers are single corporate entities, with bank accounts keeping the reserve. Other issuers are governed by smart contracts (code).?
The backing of a stablecoin highlights two things. Namely, capital efficiency and safety. Capital efficiency refers to the amount of capital available in the system to grow. Safety in this scenario is the likelihood of being able to redeem your dollar for the stablecoin. The more backed (collateralised) a stablecoin, the less capital efficient and more financially safe it is. The less backed (collateralised) a stablecoin is, the more capital efficient and less safe.
The two biggest centralised and fiat backed stablecoin players are Circle USDC and Tether USDT. What makes these players centralised is the fact that their reserves are held in a bank that is beholden to regulators. In other words, a single point of liability, but also a single point of failure. These stablecoins are capital efficient since they are backed one to one with fiat currency. This is one of the reasons why centralised stablecoins are the most used today. They provide efficiency and trust (transparent reserves, guaranteed by institutions and the law). Being backed by fiat currency leaves no volatility to contend with when considering collateralisation ratios. Thus they are efficient with their reserve allocations.?
Looking at decentralised stablecoins, we get two scenarios that arise. Under collateralised and over collateralised stablecoins. What makes a stablecoin decentralised is the fact that its reserves do not reside in a bank, but within a smart contract on the blockchain. Thus there is no single point of failure and no single entity to point to to shut it down. Within these systems certain backing ratios need to be adhered to in order to provide safety and efficiency within these systems whilst still maintaining decentralisation.? Over collateralised systems require more than $1 of reserves to issue a stablecoin. In a centralised system assets are custodied by a regulated bank. In a decentralised system assets are held in a smart contract (code).
Stablecoins who have fiat in regulated bank accounts backing its stablecoin are what we will be deep diving into now. Tether, a fiat collateralised stablecoin, the issuer of USDT, is the most demanded and liquid stablecoin. It was the first stablecoin to arrive and as such became the most widely used and issued stablecoin.? USDT are blockchain IOUs which allow one to redeem dollars in their reserves. These reserves are composed of cash held in a Bahamas based bank, US treasury bills and other fixed income assets. Tether has had a history of regulatory scrutiny. To date it still hasn’t produced statements of its reserves and are still under investigation? As of April 2022 there has been an issuance of $81B USDT. Circle USDC, another issuer, is fiat collateralised but in a more regulatory friendly setup. Their reserves consist of cash and short duration US treasury bills. This means they can withstand any sudden surge in demand for redemption of their Stablecoin -i.e. their reserves are highly liquid. They are ahead of the pack when it comes to establishing a relationship with the US government. Circle have been proactive in meeting with top brass at various regulatory institutions not only in the USA but also in Europe (UK). As of April 2022 they have an issuance of $51B. Paxos is the the issuer of Binance’s (a centralized crypto exchange) BUSD. Like USDT and USDC, every BUSD is backed 1 to 1 by cash and US treasury bills. Their offering is regulated by the New York State Department of Financial Services. They’ve also recently established a relationship with Paypal and Mastercard. As of April 2022 their issuance has been $18B.
The next Stablecoin category is crypto backed stablecoins. MakerDAO in the form DAI have a collateralized lending model. Users can deposit crypto assets into a vault, the system then can issue their stablecoin, DAI. The collateralisation ratio is 150% meaning users can borrow 66% of their collateral value in DAI by depositing ETH as collateral. Due to volatile assets being accepted as collateral (ETH), a higher collateral ratio is required within the system. ETH and USDC are accepted as collateral. Having USDC as backing still makes the DAI somewhat centralised by inference. They are still vulnerable to the regulatory pressures of the USDC assets that lie in their vault. However, despite this the entire system could easily pivot to another asset if that did become the case, the MakerDAO system is still further away from regulatory purview than fiat backed stablecoins, due to none of their assets being backed by real dollars. Liquity LUSD have established themselves as purists in light of MakerDAOs compromise with USDC. Going for a more direct line of censorship resistance and minimal governance, they have won favor with many DeFi purists. Their collateralization ratio is only 110%, trying to improve on the capital efficiency. Users are incentivized to protect the backing in times of system stress by being rewarded with governance tokens and discounted ETH during liquidations. Governance tokens are crypto assets that represent voting rights. These voting rights allow holders of the asset to vote on proposals pertaining to the development and modification of the protocol. It’s a way to distribute decision making power to the community.?
Mixed systems such as FraxFinance FRAX have implemented a mechanism to allow over collateralisation and under collateralisation in the same system. It’s referred to as a floating collateral ratio. The issue with systems that are under collateralised is, whilst being capital efficient, once confidence is lost, there’s a race to the bottom as people redeem what collateral is still available. Frax mitigates this by allowing their collateral ratio to be determined by market forces. When there is excess demand, buying slows down through an decrease in collateral. When there’s excess supply, buying increases through an increase in the collateral ratio. Once the peg is restored it will return to homeostasis. This is all determined algorithmically as levels are monitored by the system.?
These are the top 5 stablecoins with their metrics and numbers as of 2022/07/28
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The two main axes upon which a stablecoin is judged is centralisation and collateral ratio. The more decentralsied a stablecoin is, the more censorship resistant? - tougher to shut down. The less collateralized a stablecoin is, the more trust is required in the system. The more collateralized a stable coin the less capital efficient it is.?
Since April 2020 there has been a huge explosion in stablecoin activity and market cap. With centralised stablecoins like Tether USDT and Circle USDC leading the way. As of 2022/07/28 the combined market cap for all stablecoins is $154B with a daily trading volume of $65B.
Chart by Nansen.ai
Daily on-chain volume has also grown steadily since Jan 2020 up until now - Jul 2022. Again, as you can see much of the volume is generated from Tether and Circle.
Chart by Nansen.ai
These are the exchanges with the most stablecoins.
Chart by Nansen.ai
Stablecoins provide an opportunity to have censorship resistant assets in the form of tokenised price stability or cryptodollars. The price stability protects purchasing power and mitigates market volatility for users. These are very important features within a financial ecosystem. Some stablecoins are more centralised than others and as such are not censorship resistant. A Government would have the power and reach to shut them down. Well designed stablecoins would be able to resist being censored because all their operations, including their collateral reserves will be stored on the decentralized blockchain and not in banks. Individuals in countries where inflation is soaring can have the option to protect their money through stablecoins - helping them maintain their purchasing power.?
Due to the global nature and ease of access to these stablecoin assets, one could see monetary sovereignty under threat as users swap usage of their native currencies to various stablecoin variants. The purpose of blockchain technology is to separate money from the state - to reduce monetary sovereignty. Such that there is equal access to money, equal opportunity to preserve purchasing power and the reduction of economic leverage the government has over its people. Stablecoins give people the very important option of exiting a system that no longer serves them. People don’t have to be beholden to their government who choose to exercise certain monetary policies. Right now it's not a clear substitution between fiat currencies and stablecoins. The blockchain still needs time to develop and become more widely available and understandable to the mainstream. Therefore, as of this moment, no, monetary sovereignty is not threatened. However, in the future it may well be.
Thanks to Alessandro Scarcella for reviewing drafts of this piece. ?
BDM at Silicon Signals Pvt. Ltd. & founder at The Perfection Organization
2 年Yes, that true! Liam... Thanks for this amazing post,