If you are trader/speculator, volatility is your friend. If you are using Tokenomics to fund a venture, volatility is also your friend; you sell Tokens into a rising market in order to fund the business. There are other situations where volatility is your enemy and stability is your friend. A new generation of Stablecoins are entering the market to meet these needs.
This is Part Three (Chapter 5) of The Blockchain Economy book. This serialised book is a practical guidebook for investors, entrepreneurs and employees who want to learn how to prosper during the transition to an economy where value exchange is permissionless and disintermediated. For the index/table of contents of The Blockchain Economy book please click here.
Note: updated after Basis shutdown news. Updated text shown with underline.
This Chapter describes:
- Three use cases for a Stablecoin
- Three types of Stablecoin assets
- Two types of Stablecoin peg models
- Three revenue models for Stablecoins
- The regulatory backdrop
Three use cases for a Stablecoin
- Tool for traders. A Stablecoin offers a place to park your crypto assets without cashing back into Fiat. For example, Tether/USDT is pegged to the US Dollar but it is a crypto asset. Tether/USDT is currently the biggest Stablecoin. The obvious question is why would anybody want Tether/USDT rather than simply owning Traditional US Dollars? This is use case number 1. For example, if you have some crypto assets, but are bearish on short term trends, you could trade those crypto assets back into US Dollars, but that costs a lot in fees and taxes. Trading Fiat to Crypto or Crypto to Fiat is expensive. In contrast, trading Crypto to Crypto is cheap. So you exchange your crypto assets for USDT until you want to buy back into the market. Tether is a single currency coin (US Dollar) and the buyers are not betting long term on the US Dollar, they are simply betting that it will stay stable long enough to move back into other crypto assets.
- Long term asset stability for investors. This is for people investing for a long time horizon such as Family Offices. For example, if you are bearish on short term trends in traditional securities, you might want to go to cash or short term debt. Nobody would buy something like USDT for this purpose as it would be much easier to simply buy traditional US Dollars; but they might buy one of the new breed of multi-asset stable coins (see next section) or a coin that is backed by an asset that is independent of any Fiat currency.
- Currency to facilitate cross border payments. Bitcoin was originally conceived as a 3 legged stool (1 = store of value, 2 = currency for everyday payments 3 = interim store of value to facilitate payments). Store of value is well proven (Bitcoin as digital gold) but Bitcoin is too volatile today to be a payment rail or currency for everyday payments. If you wanted a currency for this purpose, you would create something that was almost a mirror image of Bitcoin, with the lowest possible volatility against the major Fiat Currencies. This needs one of the new breed of Multi-Fiat Peg Stable coins
Three Types of Stablecoin assets
- Single Fiat Peg . This is usually the US Dollar, but can also be EUR or Yen or any Fiat currency. Tether/USDT is the big one that has been operating for some time, but has been more recently been joined by TrueUSD/TUSD and Havven/HAV.
Basis was a Single Fiat Peg solution.
- Multi Fiat Peg. These use a basket of Fiat currencies possibly with some non Fiat hard assets. Single Fiat Peg is adequate for use case 1 = a place to park your crypto assets without cashing back into Fiat; so it is no surprise that Crypto Exchanges use them as a way to encourage trading. However, a Single Fiat Peg is no use to somebody looking for use case 2 = long term asset stability; many global investors look at US$ as a long term risk factor. For use case 3 = currency to facilitate cross border payments, a Multi Fiat Peg is also less volatile.
- Tokenised single hard asset. These are assets that have low correlation with Fiat currencies and Traditional Securities. We cover these in more detail in Part 3/Chapter 4 = Tokenised Real World Assets (fractional ownership of some “hard value” asset). There are already more than 10 backed by Gold.
Three Types of Stablecoin Collateralised.
How a Stablecoin is Collateralised is critical. This determines whether the Stablecoin really is worth what the promoter say it is. There are 3 forms of Stablecoin Collateralisation:
- 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 custodised; for a while there was serious concern that 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.
- Crypto Collateralised. In this model, the collateral backing for the Stablecoin is held in a cryptocurrency, typically ETH on Ethereum. This avoids the regulatory issues and operational complexity of holding Fiat currencies in a traditional bank account (because bankers are wary of cryptocurrency ventures). To avoid exposure to the volatility of the cryptocurrency, the amount of cryptocurrency held is dynamically adjusted. For example, if the cryptocurrency is ETH and the stablecoin is pegged to USD and ETH declines 10% against USD, the Stablecoin promoter automatically buys 10% more ETH. As crypto is unregulated, it is unclear where trust via auditing will come from.
- Issuer Collateralised. The Stablecoin issuer maintains the peg by buying when the price is below peg and selling when it is above the peg. This is how a Central Bank works and has the same issues. What happens when there is a run in the currency. Will a VC backed venture really be able to be the buyer of last resort?
Basis was an Issuer Collateralised stablecoin. $133m sounds like a lot if it was just to build a tech and maeketing team, but it is a drop in the bucket to act like a global central bank.
3 revenue models for Stablecoins
Many Stablecoin ventures recently got VC funding and there are many ways for Stablecoins to make money, including:
- Provider to multiple exchanges. Tether/USDT, the leading Stablecoin, is owned by Bitfinex, a Crypto Exchange. The business logic is simple. A Stablecoin facilitates active trading and Crypto Exchanges make their money from active trading. There is no reason for each Crypto Exchange to manage their own Stablecoin.
- Fund for wealth managers. This is where a Multi Fiat Peg asset is needed as most wealth managers will advise against excess exposure to a single currency.
- Tool for payment services. If you operate a cross border payment service, a Stablecoin is a key component, so that you are not reliant on Legacy FX exchange services.
One business model that does NOT work with Stablecoins is Token Sale Funding (sometimes called Tokenomics). This is the model where the entrepreneur funds the venture by selling tokens at ever higher prices. The whole point of a Stablecoin – price stability – runs counter to this. This is not needed as those 3 revenue models for Stablecoins are enough for them to make money from customers.
The regulatory backdrop
Stablecoins attract the attention of regulators for two reasons:
- Collateralised Stablecoins are deposit takers. That is a magnet for scammers and needs regulatory oversight.
- Stablecoins can facilitate the on/off ramps from/to Fiat/Crypto. That is a magnet for money launderers and needs regulatory oversight.
One question is – which regulator? A Stablecoin is currency and needs regulator who has oversight of currencies. For example, in the USA this is NOT the SEC which is taking action on other Tokens but does not have regulatory oversight of currencies.
Another question is – which jurisdiction? A Stablecoin is naturally global and not tied to any single currency. It maybe perceived as a threat to agencies that manage domestic Fiat currencies.This is where Switzerland is interesting for two reasons:
- FINMA (Swiss financial regulator), regulates Tokens depending on their use case. They define 3 (Payment, Utility, Asset). So there is a regulatory framework specific to payments.
- Switzerland is legally a multi-currency country. What? We all know Switzerland is multi-language, but we also know the famous Swiss Franc. It turns out that there is an alternative currency called WIR that was set up in 1934 that is quite legal. The WIR was set up by people wanting to create an alternative to a financial system that had failed so dramatically in 1929. This has echoes from 2008 and the Satoshi Nakamoto White Paper. WIR accounts for a tiny % of Swiss GDP but it is real and legal. So the idea of adding another legal currency was not too big a stretch. That is why you can pay taxes in Bitcoin in Switzerland and buy Bitcoin at any railway ticket machine. It is also why a Stablecoin that plays by the rules can be a legal currency in Switzerland.
This question – which regulator – hit the front page this week with the Basis shutdown. In this week’s Blockchain Economy Front Page, Ilias Hatzis asks the very pertinent question of what damage over zealous regulation does to the wealth-creating impact of innovation.
Check out our advisory services (how we pay for this free original research).
To schedule an hour of Bernard’s time for CHF380 please click here to send an email.