Stablecoins - Will Dollars Go Digital?
How we get paid, pay others and transact is slow to evolve. The US dollar for example has only had 2 evolution points in the last 100 years - 1914 and 1971.
1914 was when the US dollar as we know it came to exist during the establishment of the Federal Reserve.
1971 is when President Nixon removed the Gold Standard. This allowed the dollar to free float and become the reserve currency of the world.
Credit and bank cards also had a slow evolution. The first credit cards were single store issued in the 1900s - think Macy's department store. Bank issued cards came into existence in the late 1940’s and 50’s.
The magnetic stripe came in 1960, smart cards (EMV) in 1990’s, and RFID in ~ 2010’s (Apple Pay was 2014). 20 year clips for these advancements.
Thanks to the creation of Bitcoin and blockchain, another leap forward is possible. One of the more interesting aspects is the potential for paper central bank currency to go away( US dollars, Euro’s, etc) and payments that can be near instant.
Blockchain technology allows for this to become a reality. However, Bitcoin price volatility stops many from using it as their primary currency. Luckily, creative people have produced a potential solution - stablecoins.
Why Were Stablecoins Created
Stablecoins were created to bridge the gap between digital crypto currencies/assets and real world assets. The thinking is this - if crypto assets are built with the backing of real world assets there could be a reduction or removal of price volatility.
A reduction of price volatility will then make them more attractive to everyday people. In turn, making them more accepted for payments and storing value.
Let’s be honest - if your buying power can move 50% higher or lower at any given time. It’s likely you won't keep a large part of your net worth in that asset.
Types of Stablecoins
Currently stablecoins come in four varieties: fiat, crypto, algo & commodity.
They will also either be off-chain or on-chain. The average person likely will only take part in fiat backed stablecoins. But it is worth knowing about the others.
Fiat Collateral (Off-Chain)
Right now the most popular stablecoins are backed 1:1 with fiat currency(US dollars, Euros, etc.). Since US dollars and Euros exist in the physical world. Stablecoins with their backing are known as off-chain assets.
The fiat collateral must be held in reserves at a central custodian or a financial institution. And the amounts must be in the same proportions to stablecoin supply.
example: $50 million of a US dollar backed stablecoin would need to have $50 million of US dollars sitting in a custodian or financial institution.
Crypto Collateral (On-Chain)
Crypto stablecoins have backing of another crypto currency as collateral. This is done with smart contracts instead of a custodian or financial institution. Hence they are on-chain.
The process looks like this: you would lock your crypto currency into a stablecoin smart contract and receive tokens of equal value. To receive your collateral back. You place your acquired stablecoins back into the contract, releasing your original collateral deposit.
Note: crypto collateral stablecoins may require you to over capitalize your position. Meaning, $1,000 worth of the stablecoin may require you to put in $2,000 worth of collateral.
Currently, DAI is the most known stablecoin using this collateral method. DAI is issued by MakerDAO.
Algorithmic stablecoins do not use fiat or crypto for collateral. Instead, algorithms adjust the supply of stablecoins. This keeps the market price in line with the fiat it tracks.
example: if the market price goes above the tracked fiat, the algorithm increases supply to drive the price lower. If the market price goes below the tracked fiat, the supply is reduced to increase the price.
The collateral backing commodity stablecoins are physical assets. These could be precious metals, oil or real estate. The goal of these stablecoins is to allow investment in assets that may not be physically available locally.
For example, you may live in a region where buying physical gold is difficult. And storing that physical gold adds complexity. To get around this you could buy tokens of Tether Gold.
Owners of Tether Gold have the option to exchange tokens for physical gold bars. To do so, owners must hold a certain number of coins and pass a verification process. Once completed, they can receive physical gold bars from a number of locations in Switzerland.
There are two negatives to these coins:
First, not all commodity backed coins allow for conversion to the physical commodity.
Second, commodity backed coins have higher price volatility than those pegged to fiat. That means you can lose money.
Payments & Remittance
Being able to transfer value to someone in a quick and efficient way is desirable. Stablecoins allow you to do this.
By removing the traditional banking system the costs go significantly lower and time to delivery is cut. For those of you who send money via ACH or bank wire you know how painful it is.
The world is also global. There are workers living away from their home country and need to send money back to their family. This is remittance payments and it is notoriously slow and expensive. Stablecoins are a way for them to get money home to their family as soon as possible. They also will receive near 100% of that transfer amount by removing costly middlemen. In fact, they may even gain value depending on conversion back to their home country currency.
Store of Value
In some parts of the world there are people who are unable to access the banking system. Because of this they store their valuable cash in unsafe ways. The use of stablecoins allows them to store what they accumulate, while reducing risk and preventing value from eroding thanks to inflation.
Even cash sitting in a bank is eaten by inflation. To learn how, check out our blog post, “What is the Real Cost of Sitting In Cash.”
Additionally, you may not want to accumulate cash in your home currency. Stablecoins allow you to buy what could be viewed as a stronger currency. This increases buying power.
For example, people in Venezuela look to find ways to convert their Bolivar to other currencies due to government instability and hyperinflation. Extreme cases can be seen in news stories like this.
Will Countries Go Digital?
Bitcoin, blockchain and stablecoin technology provide a way out of the traditional banking system. This has central banks concerned they will lose control of monetary policy. Because of this fear, central banks are looking into creating digital versions of currency.
China is at the forefront. They currently have a test program using an in-country digital yuan. The digital yuan allows them to track user spending in real time, and gives them a currency not tied to the dollar dominated financial system.
This allows them to track the population further. While also potentially gaining a way to skirt around WTO trade agreements and possibly sanctions. Harrison Dent of Georgetown Law speaks to this in,
Not good for Chinese citizens, nor US financial dominance.
Europe’s ECB is currently researching the potential for a digital Euro. The ECB view is for the digital Euro to be a complement to the current system, not a full replacement.
Christine Lagarde, the ECB president, was quoted, “Our work aims to ensure that in the digital age citizens and firms continue to have access to the safest form of money, central bank money.”
The risk of currency going digital also has the interest of the US. This week Treasury Secretary Yellen gave her view on stablecoins when she was quoted,
“Bringing together regulators will enable us to assess the potential benefits of stablecoins while mitigating risks they could pose to users, markets, or the financial system.” - Janet Yellen
It is so top of mind that the US is also doing research on the possibility of having a digital dollar alongside our current system. Like the digital Euro.
The evolution of money and how we transact as humans has been a slow timeline. Now with blockchain technology and stable coins. The potential for a quantum acceleration is on the horizon.
Shortening of payment times, reduction in transfer costs and allowing the unbanked to have a legitimate way to store value is huge. It helps make sure no person is left behind because of how the current financial system is built.
China is leading the charge and other nations are trying to decide how they will take part. But the most important thing is the financial system as we know it needs to evolve.