This week’s cryptocurrency nosedive highlights what can go wrong when value is wholly pegged to sentiment. While investors are gasping for breath, others are looking for solutions. Could Stable Coins be the answer?
If you are the type who cares about the inner workings of something like a blockchain, you’d know about a secret message that’s embedded in the original Bitcoin coding. It’s a provocative little line of code that calls into question a government’s ability to stabilize monetary systems. Put there by the founder of Bitcoin, it also suggests that Bitcoin is the solution to instability.
But in light of this week’s drastic and alarming selloff of Bitcoin, that entire notion gets turned on end. Bitcoin is down 42 percent in November alone. As investors flee cryptocurrency in general, the total market value of Bitcoin and its rivals has fallen from more than USD$800 billion last January to around $130 billion as of November 27, 2018.
So much for stability.
The Solution for Instability is Now Unstable Itself
Satoshi Nakamoto’s not-so-cryptic message can be found deep within what’s known as the “Genesis block”, or the code for the first fifty Bitcoins. There, the Bitcoin creator wrote:
The Times 03/Jan/2009 Chancellor on brink of second bailout for banks.
This is generally interpreted as a criticism of the instability of traditional currency systems. It’s definitely a reference to a London Times article of that year criticizing the British government for failing to keep the economy from falling apart. It’s also a major critique of the banking system used in most parts of the world: fractional banking.
The solution that Bitcoin was supposed to provide, and which promised stability, was that the number of Bitcoins would never be allowed to run rampantly wild. That’s quite different from fiat currencies, where governments can print all the money they see fit thereby allowing the supply to grow well beyond actual reserves. That can lead to instability, among other financial risks and dangers.
As we all know, generating just one BItcoin is an incredibly resource-intensive endeavor. That’s a built-in safety feature, a hedge against much of what’s wrong with traditional currency systems.
But you can’t rely on a medium of exchange that fluctuates by as much as 20 percent on a good day. Bitcoin has been particularly volatile lately, which has not only fueled speculation but also damaged its reputation in the eyes of would-be mainstream users…those who are most likely to take up the cause of digital currencies and turn them into viable options for people to use every day for the normal transactions of daily living.
What might satisfy the requirements of this type of real-world adoption? One answer could be stable coins.
What are Stable Coins?
Stable coins are a hybrid cryptocurrency. Unlike Bitcoin, which is all bit and no coin, a stable coin is usually tied to the value of a fiat currency. Take, for example, Tether.
Tether’s USDT is tied to the value of one US Dollar. For every USDT out there, there’s a Dollar to back it up somewhere in a Tether bank account.
This provides the much-needed lynchpin that would secure mainstream acceptance of a cryptocurrency: stability. If consumers are going to rely on digital currency, they’ll need protection from market volatility.
There’s a philosophical problem, however, with tying Tether to a fiat currency. It’s a centralized solution that pretty much flies in the face of Sakahi Nakamoto’s code-embedded vision of decentralized, blockchain-based currency systems.
Enter Havven, another Stable Coin. They curb volatility by holding the bulk of their collateral tokens in escrow. There are incentives for people to back the collateral tokens, called Havvens: they profit whenever the transaction currency, Nomin, is used. For these stakeholders, there’s no compromising on the Nakamoto founding vision of decentralization because they don’t peg their currency to any centralized fiat currency.
USDX also avoids the irony of pegging itself to a fiat currency. To achieve stability, they do indeed match their value to the US Dollar but more indirectly, with checks and balances in place.
Those checks and balances come in the form of a complex algorithm (surprise surprise) that essentially serves as a central bank for the currency. Exchange rates are “monitored” by a third-party service that draws upon different exchanges around the world and submits rates to be approved or rejected by randomly chosen stakeholders. Thus, decentralization. Thus, transparency. Thus, reliability.
Stable coins don’t have to be pegged to the US Dollar. Gregory Klumov, STASIS CEO, takes a more global perspective:
“It became obvious for all market participants and liquidity providers that stable coins are must-have assets in cryptocurrencies marketplace. Some exchanges even made impulsive moves listing all USD based stable coins they could find. United States Dollar is a separate animal in global currencies world as it is still unclear will CFTC wins its position to classify USD stable coins as commodities.
So initiatives coming from Singapore, Switzerland and an actual legislation on Malta are very much on time to legitimize stable coins in other nations.”
What About Regulation?
Havven, USDX, and Tether aren’t the only players in the Stable Coins game. There are other currency pegs out there (MakerDeo, TrueCoin, and Basecoin, for example). Of course, the problem is, history has shown that currency pegs aren’t resistant to volatility, either. And hello, why was Bitcoin developed in the first place?
Extremely adverse conditions can dismantle even the strongest of currencies but the fact is, most can withstand a certain amount of market behaviour craziness. And that’s what Stable Coins are counting on.
Others, like IMF chief Christine Lagarde, believe that regulation is the answer.
Bitcoin has had roughly a decade to prove its mettle and failed miserably on the stability front. This obstacle has served as a bottleneck for mass adoption, rendering digital currencies little more than speculative operations. One way around this is to have governments step in and help.
In the interest of crime prevention (money laundering and terrorism), governments are already putting stops on the use of digital currency. But Lagarde’s vision is different. The aim isn’t necessarily to stop the evolution of new payment systems. It’s to make them safe for general use. Clearly, consumers need protection (and so do investors, who are currently losing their shirts on the markets).
Ms. Lagarde even thinks that central banks should consider getting in the game by issuing digital currency. Indeed, the endgame of regulation should be about opening up possibilities rather than clamping down on innovation.
Regulation or Stable Coins?
Whether it’s stable coins or regulation on the international level, digital currency still holds promise for improving the way we conduct real-life financial transactions. We merely have to open up the discussion and begin to consider digital currency as a viable (potentially stable) option not just for our personal transactions but also our banking infrastructure. The more people get involved in the discussion, the sooner we can overcome the challenges to using cryptocurrency.