In search of Money — episode 4: Stablecoins and future of money
Hello people of Earth! We live in an exciting time.. as if there was a generation who could say the opposite.. Anyways, as we’re dashingly moving into new decentralised model of economy we decided to cover the topic of money as we think that its form is transforming extremely fast creating gaps in understanding its nature which is essential for making smart moves in the coming future world. You all use cryptocurrency term a lot, most of you are very well aware of the stablecoin notion, maybe not so well of the decentralised reserve currency ideas while many probably struggle to understand the mechanics behind token minting process performed by various DAOs offering crazy APYs. As this is quite a topic, the material will be released in four episodes:
Issues with the modern fiat money
Cryptocurrency to replace fiat?
Stablecoins and future of money
This is the final episode of the series where we are exploring the nature of money while trying to understand what to expect in the forthcoming years. Hope you guys have enjoyed the articles so far as they should have laid the foundation for what we will be covering today - future of money.
Last time we paused at stating that cryptocurrency is the best form of money that humanity have seen so far provided it is legit, i.e. not created just to rag pull people. You might recall from the last post that technically all cryptocurrencies can play the role of money as long as there are two persons who agreed to use it as a means to transfer value (i.e. exchange for the other assets or services). Two people obviously is not enough when it comes to consider certain cryptocurrency as money since if the rest of the population does not agree to use that currency then it will exist only as long as those two people continue to use it. As we know now the purpose of money is to ease universal exchange of value across the planet thus having just two people using it does not make it universal at all.
Then what makes people to agree to use something as money? During the last hundred or so years these were national states with they central banks who forced people to use their national currency and since people did not mind and it was convenient we can say that they agreed to that. In rare cases some still used gold, diamonds or other not always legal things but 99% of total value turnover was made via national currencies. Despite governmental monopoly to manage money we know that in some countries people still use USD instead of local national currencies and that is the example where social agreement trumps the local national state regulation if people disagree. This is important because this shows the brutal force of society if it does not agree with something that does not work for them. Therefore, in the end it is the social agreement and acceptance that makes something money and something just trash based on how well this something can play the role of money. In the previous episodes we talked about how well cryptocurrency can play the role of money. TLDR: very well, much better than centralised national currencies.
You see now why central banks and majority of governments are so afraid of cryptocurrency. They understand very well that it is superior to fiat money. That is why many of them now are hastily developing their own central bank digital currencies (CBDC) trying to overtake public favour towards crypto. But CBDC is centralised and though it indeed is more advanced than existing fiat money it is not that good as decentralised cryptocurrency because it is susceptive to manipulation (e.g. sudden increase of supply because someone decided to win votes by increasing social payments).
No question that public will prefer decentralised versions, i.e. cryptocurrencies and as we just discussed it will go for those which have wider recognition and acceptance. Actually it is fair to say that any of top 100 cryptocurrencies by market capitalisation (which to large extent represents the popularity, i.e. public acceptance) is already used as money more and more.
Now, let’s address the biggest hurdle that prevents crypto from taking over the world in just a year or so. Price volatility. You cannot really do business sustainably or plan your personal finances if you do not know how much the cup of coffee will cost tomorrow. Indeed, this does not help the adoption of crypto but it is inevitable pain (price) of the growth of this new industry. You see, crypto has no national borders, it belongs to the whole planet and since money is just a reflection of the real world assets (goods, services, resources) it is very difficult at the moment for the society - let alone governments - to accept the fact that crypto will be representing the worth of the world economy of the whole planet. It is just difficult to embrace - how much is it?Crypto currencies are in the space right now where they have captured just a fraction of the the whole world’s value thus they have mind-blowing potential to grow further but on the other hand this idea is so new that even though rationally it makes sense we just cannot yet believe it is possible. Therefore we are in this multi-year price discovery mode until crypto devours the capitalisation of the whole planet. Of course not all cryptocurrencies have the ambition to be used as world money, some just represent the value of product, service they provide, so they do not care about stability and have no intention to have that and in this sense it is not convenient to use them as money on daily basis so… here come the stablecoins.
Recently we’ve been observing a massive growth of those as indeed there is a huge demand to have something stable in crypto space to manage personal finances, do business and even shopping. However you should bear in mind that currently all stablecoins are pegged to fiat money, i.e. USD in most cases therefore they are not that stable in terms of value as we know that USD depreciates over time, i.e. you can exchange it for less value in the future. But in comparison to crypto, yes, you can say that USD is more stable, thus its blockchain ‘twin-brother/sister’ can be considered as somewhat stable. Most likely you know how these stablecoins work - they are backed up by something else that has value, i.e. the amount of stablecoins in circulation is always less than value of assets they are backed up with. There are two major types of assets that are used to back up the stablecoin:
Real world assets - gold, bonds, fiat cash
People buy such stablecoins with fiat directly or using other crypto which gets converted to cash or to bonds and it goes to treasury so if all people suddenly sell such stablecoin there is enough assets to buy all stablecoins back at $1 price. Theoretically if you have $100,000 worth of assets in the treasury, you cannot mint $110,000 worth of stablecoins. Moreover you cannot mint even $100,000 worth of coins, because the bonds or gold in your treasury can depreciate in the real world, thus your collateral should be always worth more than the worth of stablecoins in circulation to have buffer in case the value of assets in the treasury decreases. So in case of $100,000 worth of treasury it is wise to mint $70-80k worth of stablecoins. The big problem with these types of stablecoins is that currently they are not trustless. You have to trust the issuer / protocol that its treasury has sufficient wealth and since we are talking about fiat in the bank, gold in the safes it is hard to validate.
Other cryptocurrency
This is where you can lock your BTC or ETH or BNB or even LP (liquidity provider) tokens which have value in the vault and mint the equivalent worth of stablecoins. Again, in order to ensure healthiness of the system, you will need to put more value in the vault than you will get in the minted stablecoins. E.g. you’ll need to put $1,000 worth of BTC to get $700 worth of stablecoins but it is not that you are losing money here. You will have your personal smart contract (Collateralised Debt Position - CDP) which will lock this ratio so you can always return stablecoins to the protocol (i.e burn it) to get the same amount of BTC back. This system is much more transparent and truly trustless.
There is an emerging sub-type - algorithmic stablecoins. It involves the reserve cryptocurrency, i.e. the stablecoin protocol has two currencies - the main protocol-reserve coin and the protocol stablecoin. Here you cannot put other known cryptocurrencies as collateral to mint stablecoins, you can only put that protocol-reserve coin as collateral to mint stablecoins. The price of the protocol-reserve coin (which is used to define how many stablecoins you can mint) depends on two things:
1. the demand for this stablecoin
2. the inflation rate of the protocol main currency
The demand for the stablecoin is crucial for such projects. If it has high demand, i.e. more people use it for daily operations it means the collateral should also increase in order to mint more stablecoins otherwise the price of the stablecoin will increase if the supply does not keep up with the demand and this is opposite to the notion of the stablecoin. Thus instead of allowing the price of stablecoin to increase, the protocol incentivises people to mint more stablecoins by giving beneficial rate (i.e. for $1 worth of main protocol-reserve coin you can mint $1.1 stablecoins). That makes people buy more main protocol-reserve coins to mint stablecoins therefore the price of the main protocol-reserve coin goes up while the stablecoin price on the market remains around $1 as supply increases with the demand. If demand for the stablecoin goes down, the protocol incentivises to burn $1 stablecoin for $1.1 of main protocol-reserve coin thus the supply of stablecoin decreases thus not allowing it to go under $1. The above determines the price of the main protocol-reserve coin but what also impacts the price is the inflation rate of the main coin. If it has the inflation rate of 1000% then obviously even the high demand for stablecoin (which leads to high demand for the main protocol-reserve coin) cannot push its price up as the increased demand will be met with the increased amount of main reserve coins in the market.
This model is even more transparent. It is trustless and self-regulated. It is simple and thus resilient. It has direct correlation with social acceptance (it lives only if people use it). It is based on value that people commit to lock to back up the minted amount of tokens (i.e. it is not based on arbitrary decisions of people in the official cabinets). Finally usual people get access to participate in the stablecoin-isation of the world. Thus we think this is the model that will become dominant in terms of future of money. The reserve currencies will be that value accumulation monster that will translate its value through the volume of minted stablecoins that people will use on daily basis.
The next big milestone that we will need to face at some point is breaking the link with the fiat money, i.e. having new token which is stablecoin but not pegged to USD. This will come with much more mass adoption of crypto than we see now plus we will need pioneers who will offer such stablecoin. It means that it should appear first and then we will need to get used to it so we can more or less easily understand what this one stable token can buy us in the same way how we can understand it in relation to 1 USD.
Hope this has been an interesting reading for you guys and thank you very much if you have made it this far.
Stay tuned!
