Discussion Post: Taming Wildcat Stablecoins

[Muhammad]

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.

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:

“Whenever you gamble my friend, eventually you’ll lose.”~ Qui-Gon Jinn

[jmcgirk]

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?

[Muhammad]

The Ethereum imitation is odd. The situations don’t appear to be the same. Also, the fork won’t have the previous transaction history.

Market confidence in a Luna of any phase will be largely backed by the faith in and credit of its system and founder. That’s been massively shaken and shook the industry. Whether people are “made whole” or not, success depends on investors giving Luna and its founder another try. If it rises up again like a phoenix, it’ll be interesting to see if he returns to taunting fate.

[jmcgirk]

Maybe he’s hoping enough people will contextualize it as something akin to the Ethereum hard fork by using those terms and that he’ll have enough runway to build something from the wreckage of Terra/Luna. He is Mr. Algorithmic stablecoin) so I expect he’ll be creating something along those lines. I wonder if they’ll go back to Cosmos

[windr]

@Astrid_CH Thanks for a very relevant and timeless post!

A key problem stated in your post is how policy makers can address the risks emerging from the existence of stablecoins. In “Taming Wildcat Stablecoins”, Gorton and Zhang propose two options for transforming stablecoins into the equivalent of public money, and thereby mitigate the authors’ perceived risks of stablecoins. One of these options is by “requiring stablecoins to be backed one-for-one with Treasuries or reserves at the central bank”.

Interestingly, this is almost exactly what is being proposed in the recent MiCA (Markets in Crypto Assets) regulation framework forthcoming in the European Union. Specifically, this new piece of wide-ranging legislation requires stablecoins to be fully backed, i.e. 1:1, by a reserve of assets. Further, MiCA requires that stablecoin issuers do not invest their funds collected from issuance in high risk investments (e.g. the funds collected by selling Dai issued through a vault), which amounts to a maximum risk capital charge of 1.6% as defined in Directive 2009/110/EC.

The first requirement is directly targeting algorithmic stablecoins, which, under MiCA, will still be legal, but will not be able to disguise as stablecoins, and are required to market themselves as ‘unbacked’ crypto assets. It is unclear how this will affect algorithmic stablecoins, but I would imagine a severe drop in retail investors acquiring ‘unbacked’ crypto assets.

The second requirement has the potential to significantly alter the business model of stablecoin issuers, who typically obtain a large amount of their profits by taking a leveraged position with the funds received from stablecoin issuance, i.e. by borrowing money through issuance and investing the funds received by token acquirers. This poses an interesting question of whether adequate incentives will indeed exist for stablecoin issuers under the MiCA legislative framework, and, if so, how it will affect the DeFi ecosystem in Europe.

This is indeed interesting times for DeFi, especially when it comes to regulation and the interplay between governmental actors trying to hold on to financial and monetary policy capabilities and the raging innovation of the DeFi ecosystem. Personally, I am also curious as to whether globally harmonized regulation in DeFi will emerge, or, if not, whether e.g. stablecoin issuers would be able to operate outside Europe to avoid being subject to MiCA.

[Humphery]

Hello @Astrid_CH your article is a fine piece of work nicely written.

I will say that Some stablecoins are designed to be pegged to a specific fiat currency, such as the US dollar, while others may be pegged to a commodity, such as gold.

Whether or not stablecoins can be considered “money” depends on how they are used and the specific legal definitions of “money” in different jurisdictions. In some cases, stablecoins may be considered a form of money, while in others they may not be.

It is also not clear whether stablecoins could be considered “demand deposits,” which are defined as funds that are immediately available for withdrawal on demand. Demand deposits are typically held in bank accounts and are considered a type of money. Again, whether or not stablecoins could be considered demand deposits would depend on how they are used and the specific legal definitions in different jurisdictions.

Stablecoin issuers may not be considered “banks” under traditional definitions, as they do not typically offer the same range of financial services as traditional banks. However, it is possible that a stablecoin issuer could become a bank in practice if they begin to offer a wider range of financial services.

It is a matter of debate whether or not the sovereign (i.e., the government) should have a monopoly on money issuance. Some argue that a government-controlled monetary system can help to maintain stability and prevent financial crises, while others believe that competition among private issuers can lead to more innovation and greater efficiency in the financial system.

As for the design of central bank digital currencies (CBDCs), Gorton & Zhang’s article discusses two potential approaches: a digital currency token and a deposit account with the central bank. Each approach has its own pros and cons, and the best design may depend on the specific goals and needs of the central bank. It is possible that other designs may also be developed in the future.

[Humphery]

@Astrid_CH

Die Rothschild Familie is a famous and influential European banking family with a long history dating back to the 18th century. The family has been involved in a wide range of business ventures, including finance, real estate, and philanthropy. It is not clear how this topic is related to stablecoins or central bank digital currencies.

Regarding the concept of levying on issuing notes, it is possible that you are referring to the practice of seigniorage, which is the profit that a government or central bank generates by issuing new currency. Seigniorage can be a source of revenue for governments, as the cost of producing new currency is typically much lower than the face value of the notes or coins. However, the use of seigniorage as a means of financing government spending can also have negative consequences, such as inflation or currency devaluation.

It is a matter of debate among economists and policymakers whether or not the practice of seigniorage is beneficial or harmful to an economy. Some argue that it can be a useful tool for financing government spending, while others believe that it can lead to negative consequences if not used responsibly.