Discussion Post: Taming Wildcat Stablecoins

I think the researchers mean that if stablecoins can’t satisfy NQA, then it can’t be deemed as money. Being money may result in many concerning regulations. On the other hand, stablecoins are issued by private sectors, they are not backed by the national treasury, so traders who use particular stablecoin may need to take another step to check if that stablecoin is well back so that their interests could be safe. This additional step will produce a lot of costs in an entire society. Maybe these are why the researchers regard NQA matter in the discussion of stablecoin’s nature.

The researchers suggest the government issue digital fiat currencies which money backed up by the national treasury, so-called CBDC, that are issued by central banks and are different from stablecoins which are issued by private sectors. I think some fiat currencies may not satisfy NQA because their countries are in huge debt or at war what will diminish their back, and people still need to check their value. So I think fiat currencies or CBDC might not definitely satisfy NQA.

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George Selgin from the CATO Institute argues that the comparison with the US’s wildcat banking years is flawed — it had nothing to do with consumers. “If it had,” he said, “there’d be no need for a punitive 10 percent tax to force state banks to quit issuing their own notes.” (from Sebastian Sinclair at CoinDesk). Who would really be benefiting from forcing stablecoins to adhere to NQA standards?

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It reminds me of a mystery story I have heard about Die Rothschild Familie. Though I’m not sure if it is true and if this topic has anything to do with them. On the other hand, I believe levying on issuing notes would be beneficial to the government. Think about the battle of currencies between countries can tell.

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Yeah, I agree it is undeniable that the United States has benefited from a strong currency (especially now), I think the quotation above is aimed more at the idea that the federal government is benefiting at the expense of the people it serves… which is a constant struggle in American history (states rights vs. federal). It’ll be very interesting to see what happens with El Salvador and to see who comes out ahead.

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Recently, SEC’s Chairman Gary Gensler mentioned the wildcat banking era of 1837-63 in the U.S. when he talked about cryptocurrencies (Kiernan, SEC’s Gensler doesn’t see cryptocurrencies lasting long, Wall Street Journal, 2021). It looks like that the regulation on cryptocurrencies will become harsh.

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Coming to this subject as a naive reader, I have to ask why anyone would issue a private Stablecoin in the first place. Unless you’re trying to profit disreputably by facilitating money laundering or otherwise acting as a “shadow banking system,” what could be the source of the utility?

What Gorton and Zhang say is: “Stablecoins are a new form of private money that can add value in cross-border transactions for firms and banks.” I.e., Stablecoins can serve as a common denominator for countries using different currencies.

This seems a modest but valid role for Stablecoins. It does NOT require them to “be like money” or to satisfy the NQA principle across an entire society.

At the other extreme, we have 1) Facebook—a company that has always shown the naked ambition to become or replace society—deciding to conduct its business within an FDIC-insured bank and thus make its Diem coin ultimately indistinguishable from the US dollar…

Or 2) the issuer of another prominent Stablecoin, Tether, found to be less than honest about the backing of their virtual currency, with the apparent motive NOT of “adding honest value” to a transaction but playing digital three-card-Monty and moving “the value” around so quickly that no consumer can say for sure where it really is at any given moment.

I agree that the interests of the Feds may at times be in conflict with the interests of the States, but if the sovereign can’t dictate the terms of the money supply, there’s no basis for being the sovereign.

So my naive question is: Beyond the function of “adding value in cross-border transactions,” what is the utility of issuing and using Stablecoins in the first place?

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The easiest answer to this question that is a “legitimate” usage would be to facilitate wholesale purchasing giving “club” members the power to purchase things wholesale while building the organization’s buying power without directly making purchases at any given time. Effectively, creating a private stable coin amounts to a “treasury” that the community or organization can decide how they want to allocate the funds. Some use the pool as a means to provide liquidity to the stablecoin, while others use the funds to facilitate businesses operating by covering the costs and then reimbursing the pool with the profits from the business.

The problem with framing the argument against Tether or any other stablecoin is ultimately the Federal Reserve has succumbed to the same problems and thus it undermines the notion that Tether’s fraud potential is somehow any different than the fraud potential the currently exists in fractional-reserve banking.

Ultimately, the main utility is pooling funds to give the capacity to direct the reserve. That is a desirable outcome for any organization. Stablecoins make that easier. On the other hand a floating token then provides another avenue for “speculation”, whereas stablecoins are much harder to arbitrage themselves on speculative trading.

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@Larry_Bates Regarding “the notion that Tether’s fraud potential is somehow any different than the fraud potential that currently exists in fractional-reserve banking,” I would love to understand this better via some specific examples and/or suggestions for further reading.

Again, I was referring to Tether’s initial claim that 75% of its tokens were backed by “cash and cash equivalents,” a claim later found to be fraudulent. Is it fair to say that the Fed has “succumbed to the same problems”?

On your point that “the main utility [of Stablecoins] is pooling funds to give the capacity to direct the reserve,” my (admittedly) naive question still stands: “Why not just do that with dollars?” How exactly do “Stablecoins make that easier”?

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So, I think it’s reversed: Tether succumbed to the same problem the Federal Reserve has had over multiple decades. Fractional reserve banking has shown to be a problem multiple times in the Federal Reserve’s distribution of funds to national banks. In other words, Tether just followed the same practices of the Federal Reserve, not the other way around.

“Why wouldn’t people just use US Dollars?”

Considering Americans only make up a small percentage of the global population, establishing the US Dollar as the global reserve currency is clearly a means of maintaining US dollar dominance, effectively giving the US government (Federal Reserve) a lot of influence over global monetary policy.

Getting away from a USD peg legitimately strips influence over the global economy from the US government. That alone is a reason for an organization not interested in the US government’s goals to not hedge their capital in USD.

Assume users of stablecoins are not necessarily American, and the motivations become much more clear.

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@Larry_Bates When I described myself as “admittedly naive,” I probably should have said “willfully naive” — i.e., for the purposes of getting down to first principles.

I completely get your point about “legitimately [stripping] influence over the global economy from the US government.” That certainly sounds like a bigger-sounding issue than “pooling funds to serve the interests of a group.”

If I were answering my own question about “Why not use US dollars?”, I’d probably home in on the issue of decentralization.

Do you have any specific posts or summaries, etc. that focus on decentralization specifically, and that we could use to generate deeper discussion of this key issue?

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While the language of “pooling funds to serve the interests of a group” sounds overly reductive and seemingly insignificant, what is a government beyond “pooling funds to serve the interests of a group”?

Effectively, every government operates at that level with a varying degree of influence by a varying minority/majority of the group on how the funds are allocated. I try to use language that applies at the macro/micro level so that it is more likely to be “correct” in alignment with reality than trying to use extremely scenario-specific language.

I will point to the “Prize-Linked Savings Pools” post as to why it is a good idea to diversify the number of pools in which people are contributing to retain value as not to cause a central point of economic failure. Effectively, diversifying the currencies in which a person is saving while pooling savings to create market liquidity mechanisms seem to be an element of stablecoins that make it easier for someone to create an interest-bearing mechanism beyond the poor yield associated with a simple USD savings account.

In other words, the yield mechanisms associated with USD specifically are not as good of a prospect for higher return rates than using a stablecoin-based PLS account. When you get into the post, you start to see the outsized returns on those types of accounts compared to traditional USD savings accounts. There is nothing political about it. It is provably more profitable to use a PLS stablecoin account than to use a traditional USD savings account.

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@Larry_Bates Thanks for your reply and the explanation of your use of “macro/micro” language.

Yes, I see your point more clearly now.

BTW, in following your link to PLS accounts, I came upon a succinct thread on “Why Web 3 matters” (recommended by the co-founder of PoolTogether) that quickly captured (for me, anyway) the importance of decentralization.

It’s also succinctly answers my (deliberately naive) question: “Why not just do that [pool funds] with dollars?”

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As the Financial Stability Board (FSB) (2021) observed in Regulation, Supervision and Oversight of “Global Stablecoin” Arrangements: Progress Report on the implementation of the FSB High-Level Recommendations, “At present, stablecoins are being used primarily as bridge between traditional fiat currencies and other crypto-assets, which in turn are primarily held and traded for speculative purposes” (p.1)
Stablecoins still playing the role of haven in the cryptocurrencies world currently. As the largest capitalization stablecoin, it will be a tragedy if Tether breaks out confidence risk. Thus, the Zeke Faux’ investigation that @jmcgirk posted in the comment of On the Economic Design of Stablecoins aroused concerns again.
While I don’t argue that we must tame these wildcats by over-tax to diminish them, moderate regulations are required. FSB’s recommendation and implementation of jurisdictions are notable.
Recently, Bank for International Settlements (BIS) released Application of the Principles for Financial Market Infrastructures to Stablecoin Arrangements (2021). According to its considerations for determining the systemic importance of a Stablecoin Arrangement (SA), Tether may be considered as systemic important at least because of its size and being used in cross-border payments. If so, being a SA, Tether has a much longer way to go to meet the requirements BIS set, including providing clear and direct lines of responsibility and accountability, developing appropriate risk-management frameworks, aligning technical settlement and legal finality, providing the transparency and remedy policies of settlement gaps, and the most related to the discussion in On the Economic Design of Stablecoins, “no credit or liquidity risk”, which requires transparency of its reserve to the public as the first step. When we are discussing what’s the truth behind its reserve sources and it’s still buzzing, it’s quite far from the needed confidence degree of a systemic important financial infrastructure.

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I thought I’d bring this thread to life given the recent depegging of TerraUSD and the plunge in the value of Luna (which has since recovered). Feel free to add your thoughts in here. You can watch the community discuss this issue in real time – Governance & Proposals - Terra Research Forum

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This seems to be the most active thread - [Proposal] Help UST Pegging. Increase estimated minting capacity to $1200M - Governance & Proposals - Terra Research Forum also check out Do Kwan’s thread for some interesting and valuable context - https://twitter.com/stablekwon/status/1524331171189956609 @Astrid_CH it would be really interesting to get your input.

Another interesting thread - the attack on the UST system: https://mobile.twitter.com/OnChainWizard/status/1524123935570382851

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This piece on algorithmic stablecoins in Wired claims that the “clever architecture” of UST/Terra “did not and could not work.”

And of course the whole debacle gives regulators an opportunity to rush in.

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Vitalik Buterin sent a couple of tweets yesterday expressing strong support for “coordinated sympathy and relief for the average UST smallholder.” “The obvious precedent is FDIC insurance (up to $250k per person),” he said. “IMO things like this are good hybrid formulas.”

Vitalik was responding to a tweet thread where the poster made an analogy to the Madoff ponzi restitution which also prioritized making the average investor whole, not the wealthiest.

SCRF Community: Do you agree or disagree with this idea?

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I think there is insurance available for some crypto deposits, so it’s certainly feasible. One of the things that makes the crypto ecosystem so exciting and dynamic, however, is the lack of regulation and I worry that restitution and other external authorities looking in would eventually hurt the hothouse environment that’s creating all of the innovation in crypto. Still, I wouldn’t mind a little bit of safety!

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This is indeed a very unfortunate situation and my heart goes out to everyone especially the small holders. That said, if the argument is that a government should step in, then the regulation will absolutely change the entire market and remove the appeal for a lot of community members. If taken, that’s a big step.

Additionally, the situations do not appear comparable.

Through FDIC insurance the US guarantees its own system. The US government secures its own banks for its own currency for its own economic stability and for the security of its own citizens. How would that work for something like Terra? What is it backed by that it could use to support its holders? It has no economic activity, no productive citizens.

The existence of citizens is important in considering whether to have an FDIC like scenario for smallholders. A nation’s citizens do not generally make a conscious choice about fiat. Investors in Terra/Luna algorithmic investment vehicles made a conscious choice to invest their fiat in an algorithm and its management. As investors, they are responsible for their own due diligence and they outcome of their investment, in the absence of fraud.

Insurance options might be a useful way for investors to determine the relative risk of a crypto investment. That might have been helpful in deciding whether to invest in Terra. Greed can be a powerful ally in investment decisions, and if investors saw a difference in price / risk profile from professional assessors, that may have affected their decisions and such a service if popularly used could change the whole space.

If Terra holders are investors, then why should Terra investors be treated any differently from non-insured holders of some other investment like stock or FOREX? In their due diligence, “Lunatics”, what investors called themselves, had ample opportunity to see the “master” of Terra/Luna taunting economists (warning it Terra would crash), billionaires, and other crypto projects, and to follow other news about Terra on Twitter:

They stayed in the investment. It looked successful. For some it seemed like this coin was the chosen one that would bring balance between the crypto side and the fiat side of the funds. Maybe the lunatics overestimated Terra’s power. Either way, it was their right to participate when it appeared to have the high ground the same as now when it has been brought low.

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And the story may not be over now. There could be several more episodes in the saga. For those who buy the substantial dip it may be premature attempt to bail them out.

The comparison to the system of insurance for fiat currency is not clear. If small investors made their choices based on their own due diligence and got to enjoy the gains, why not also take the L.

To be clear, I hate the fact that small investors got tanked by this bet. And I hope that the entire community develops better, clearer information for people to understand the risks they are taking. It’s just not clear that there should be restitution unless something criminal took place.

The algorithmic approach was an interesting bet, and as a wise man once said in a galaxy far, far away:
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“Whenever you gamble my friend, eventually you’ll lose.”~ Qui-Gon Jinn

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What do you think of his idea to split the chain into LUNA Classic and a new fork, is it just an imitation of Ethereum and an attempt to save some value or is there more to it?

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