Stablecoins Demand More Trust than Fiat Currency

Stablecoins Demand More Trust than Fiat Currency

This article about the problem with stablecoins was written by Kevin Murcko, the CEO at cryptocurrency exchange, CoinMetro, and forex broker, FXPIG.

Stablecoins — digital coins which peg their value rigidly to the dollar, the euro, or a collage of national currencies — are all the rage right now. Tether, in particular, is on everyone’s lips. In fact, it’s one of the most heavily traded cryptos in the market right now.

Also read: Stablecoins Fetch a Premium as BTC Hits Year Low

Stablecoins Demand More Trust than Fiat Currency

The appeal of Tether and other stablecoins is somewhat understandable. All cryptos are nascent assets; speculation, rather than the usefulness of the technology or the underlying asset, is what’s mostly been driving price movement. That’s led to wild volatility.

Traders love volatility, but not unreasonably, some people see a problem. Volatility is broadly incompatible with the concept of a day-to-day currency and a store of value. “Stablecoins” have arrived to fix this by, ostensibly, digitizing a fixed value in terms of dollars or an equivalent.

The Use Cases for Stablecoins

Certainly, there are a handful of legitimate use cases for stablecoins.

Let’s say a liquidity provider owes me $0.5 million. Maybe I need that money immediately to be able to rebalance my book — the traditional banking system isn’t the best way to do that. Even if we’re with the same bank, it can take a while to clear that transaction.

Stablecoins are useful because I can instantly clear funds back and forth. They offer the convenience and speed of using crypto without the caveat of volatility.

As the International Monetary Fund’s Christine Lagarde pointed out in a speech this month, Central Bank Digital Currencies (CBDCs) are another intriguing opportunity. While the benefits aren’t fully understood, CBDCs have the potential to limit costs and risks to payment systems, mitigate fraud and money laundering, and potentially even boost financial inclusion throughout the developing world.

Substituting Fiat Currency

Stablecoins Demand More Trust than Fiat Currency

Beyond these examples, however, stablecoins really struggle to prove their worth. Front-end, business-issued stablecoins (practically all stablecoins being traded at the moment) fall flat.

Currently, these stablecoins are used as substitutes for fiat on crypto exchanges that don’t have access to central bank-issued money. It’s not that these tokens are preferential to fiat. Rather, they’re band-aid solutions for retail exchanges which, for various reasons, can’t open and maintain adequate fiat on-and-off-ramps — usually because they aren’t properly licensed to offer fiat, or because they don’t have access to the necessary banking.

Why, in most circumstances, aren’t stablecoins preferential to fiat? It ultimately comes down to trust.

As we all know, crypto was originally intended to be trustless. The Bitcoin whitepaper laid out a vision to escape “to transact directly with each other without the need for a trusted third party.”

What stablecoins represent, in many ways, is the antithesis of that idea. The crypto community now uses privately issued tokens or coins that are pegged to the very currencies they originally wanted to pull away from. That’s problematic for a number of reasons.

Stablecoins require you to have confidence, not only in the government, but in an undependable, easily corruptible private company. We have to place our faith outside of the chain and in these companies’ ability to self-regulate supply and demand.

The Collateralization Problem

That’s a tall order. Stablecoins can be split into three states of collateralization, or the extent to which the coin is backed one-to-one by fiat. Some coins are fully collateralized, others are partly collateralized, and others are entirely uncollateralized. Unfortunately, all provide insufficient mechanics to properly regulate price.

For noncollateralized tokens, value is essentially suppressed by “printing” digital money. That’s all well and good, but when the price drops, it’s not possible to un-issue what’s already in circulation.

Here’s the snag. If the smart contract can’t keep the price at $1, then the algorithm is forced to issue bonds, promising users an entitlement to coins in the future. The bonds are then redeemed, and the price returns to $1.

That’s the theory, at least. The issue is, these bonds can only really be serviced if the platform is in an overall state of growth. The headache arises when the price keeps on dropping, and increasing numbers of bonds have to be issued until this price returns to trading level or above par. Bonds can’t be issued indefinitely.

The Fundamental Flaw: Artificial Inflation

Stablecoins Demand More Trust than Fiat Currency

Partial collateralization presents a minor improvement over the complete lack of reserve assets, but it still has a fundamental flaw: If confidence in the platform dips, then the company has to artificially inflate the price of its token by drawing on a finite pool of fiat reserves, preventing the price from plummeting. This, of course, has a limit. A company can only buy back so much of its own currency.

Presumably then, “fully collateralized” models like Tether are therefore reliable? Not really.

Even if we take the company for its word (there’s some uncertainty as to whether their assets are fully collateralized), it still doesn’t make much sense to abandon the relatively safe greenback for an inconvenient crypto that doesn’t always have fiat parity, provides no consumer protections, and is vulnerable to hacking.

Stablecoins: An Awful Idea

Central banks may not be the ideal institutions to trust, but many have stood resolutely for decades with the primary goal of maintaining our trust in their money. If privately backed stablecoins are designed to replace our reliance on these central banks with a reliance on a combination of both central banks and their loosely regulated businesses, then this seems like an awful deal to say the least.

Let’s not confuse lack of volatility with stability. That’s a dangerous mistake to make. Yes, many stablecoins do have relatively “stable” prices, but “stability” — in another sense of the word — is also about reliability, and that’s one thing that can’t be said of stablecoins, which demand far more trust than the original fiat.

Do you agree that stablecoins are overhyped? Can stablecoins solve the problem of volatility? What is the future of the stablecoin? 


Images courtesy of Shutterstock


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This is an Op-ed article. The opinions expressed in this article are the author's own. Bitcoin.com does not endorse nor support views, opinions or conclusions drawn in this post. Bitcoin.com is not responsible for or liable for any content, accuracy or quality within the Op-ed article. Readers should do their own due diligence before taking any actions related to the content. Bitcoin.com is not responsible, directly or indirectly, for any damage or loss caused or alleged to be caused by or in connection with the use of or reliance on any information in this Op-ed article. To contribute to our Op-ed section send a suggestion to op-ed (at) bitcoin.com.