Despite a prolonged crypto market cooldown since April’s all-time highs, the crypto market remains in the spotlight. The widespread potential of blockchain technology’s immutable public ledger has become increasingly apparent through blossoming crypto sectors like DeFi, NFTs, and metaverses. Accordingly, conversations appear to be moving away from if blockchain will have a role to play in society—rather, it seems the question has become how, in light of ongoing regulatory uncertainty. Specifically, disclarity surrounding stablecoins, another booming crypto sector, lies at the heart of this question.
Stablecoins are essential to the robust crypto economies we have today. Designed to maintain a 1:1 “peg” to the value of fiat currencies, stablecoins allow users to trade between utility tokens like Ethereum into familiar units of account such as the U.S. dollar. These fiat tokens enable users to exit positions correlated with the notoriously volatile crypto market without exiting on-chain economies. Without stablecoins, crypto users would depend on fiat on-ramps like Coinbase, which are expensive and time consuming bottlenecks when considering the costs and constraints of bank transfers. Moreover, stablecoins are compatible with smart contracts, meaning they can be used to compose automatically executing agreements such as derivative contracts, loans, and parametric insurance policies. Stablecoins are also becoming increasingly popular for making remittance payments.
Stablecoins are minted in a variety of ways. Tether (USDT) and USD Coin (USDC), the two largest stablecoins by market cap, are issued by Tether Limited and Circle, respectively. Both of these centralized institutions (allegedly) backs each of these tokens 1:1 with reserve assets, making the blockchain-based USDT & USDC tokens fully redeemable for the fiat currencies they represent. More novelly, Dai (DAI) is a stablecoin pegged to the U.S. dollar issued by Maker’s decentralized autonomous organization, MakerDAO. Dai’s 1:1 price peg is achieved via over-collateralization, meaning that for every Dai issued MakerDAO’s Maker Vault locks more than $1 worth of crypto asset collateral. Though Dai’s Ethereum-based issuance is inherently less prone to corruption, it is less capital efficient than USDT & USDC.
Experimentally, algorithmic stablecoins seek to achieve both greater transparency and capital efficiency than centralized 1:1 collateralized stablecoins and decentralized overcollateralized stablecoins by maintaining price peg via algorithms and game theory. Often regarded as the “Holy Grail” of stablecoins, a successful design remains elusive as infamous attempts such as Iron Finance have burned speculative investors like Mark Cuban as they experimented in the space. For now, algorithmic stablecoins are an alluring but unproven concept.
As of July 18th 2021, the combined market capitalization of the top 7 stablecoins is $110,132,502,543 according to CoinGecko. The supply of outstanding stablecoins has surged since the “DeFi Summer” of 2020, a period of explosive growth in the emerging decentralized finance ecosystem reflected in the CoinGecko chart below:
Historically, governments have mostly ignored the crypto industry due to its size and complexity. However, that is changing. As investors continue to learn about Bitcoin and increase aggregate demand for a decentralized monetary system, central banks are facing a reality wherein their ability to implement capital controls and track money in circulation is dwindling. How, then, can central banks respond? The answer may lie in central bank digital currencies, or CBDCs. Jerome Powell, Chair of the U.S. Federal Reserve, has already announced an upcoming Fed report on CBDCs that will outline benefits and risks. The report is expected to be completed by early September.
CBDCs are simple in concept. As opposed to a private entity like Tether or Circle issuing tokenized representations of fiat money, a CBDC is issued directly by a government’s monetary authority—in the US, this would hypothetically be The Federal Reserve. CBDCs may pose less risk to users by virtue of being issued by the governing authority, rather than a private centralized entity which is vulnerable to corruption, fraud, or undercollateralization.
From a government’s perspective, CBDCs present several opportunities. For one, the blockchain makes tracking capital movement easily traceable. This could enable governments to identify and intercept illicit activities through financial oversight, albeit potentially at the expense of individuals’ privacy. In many jurisdictions, fiat on-ramps like Coinbase have KYC and AML requirements, short for “Know Your Customer” and “Anti-Money Laundering”. These institutions could be compelled by governing authorities to provide customer identities tied to specific blockchain wallet addresses. Once an individual is identified as the owner of a wallet address, investigators can easily trace their capital movements through blockchain explorers like Etherscan. Though many early crypto adopters lauded blockchain for granting pseudo-anonymity to its users, the immutable public ledger may ironically become the best government surveillance tool ever created.
Another opportunity presented by CBDCs is the disintermediation of commercial banking activities. According to an April 2021 report by Citi, PwC’s Global Crypto Leader Henri Arslanian stated, “A good use-case is cross-border payments. Today, the average fee for cross-border payments is around 7%. We have nearly 250 million people across the world sending over $500 billion in cross-border remittances annually, and the fees are extremely high. It is embarrassing that we have not solved this issue so far.” Echoing Arslanian, Sarson Funds has frequently researched and invested in crypto projects utilizing blockchain to disrupt financial intermediaries.
Chairman Powell appears to have strong beliefs about the prospects for CBDCs. In response to Rep. Stephen Lynch’s question if a “swift action” on the Fed’s digital currency could “calm” the markets and make the blockchain economy’s thousands of crypto assets obsolete, Powell stated, “I think that may be the case. I think that’s one of the arguments that are offered in favor of digital currency…” Continuing, Powell said “…In particular, you wouldn’t need stablecoins, you wouldn’t need cryptocurrencies if you had a digital U.S. currency. I think that’s one of the stronger arguments in its favor.” While it reasons that fiat tokens issued and backed by central banks may obsolesce existing stablecoins, concluding that all crypto assets could be replaced by CBDCs reveals fundamental ignorance of the value offered by other crypto asset sectors.
Even as governments catch on to the virtues of CBDCs over existing forms of fiat, many will be reluctant to accept the decentralized store of value belief system that has historically fueled the crypto asset ecosystem’s growth. After all, money printers are crucial tools for governments to impose policy—especially in the US, whose dollar is the global reserve currency and can easily be weaponized. However, rejecting the core crypto ethos for decentralizing the monetary supply may work against skeptical governments in the end. As authoritarian China simultaneously advances their native CBDC while banning bitcoin mining operations, western, pro-innovation jurisdictions may be wise to embrace the decentralized wave.
Congressman Tom Emmer made a compelling argument in favor of embracing decentralization via CBDCs on Tuesday during a hearing titled, “The Promises and Perils of Central Bank Digital Currencies“, hosted by National Security, International Development, and Monetary Policy Subcommittee Chairman Himes and Ranking Member Barr. Rep. Emmer warned against mirroring China’s CBDC design, stating, “…We must not forget that the benefit of having a digital dollar would only come to fruition if it were open, permissionless, and private. Any attempt to craft a central bank digital currency that enables the Fed to provide retail bank accounts and mobilizes the CBDC rails into a surveillance tool able to collect all sorts of information on Americans would do nothing other than put the United States on par with China’s digital authoritarianism.” Later in his remarks, Emmer challenged Powell’s stance that CBDCs could replace other crypto assets. “It’s my belief that decentralized technology like cryptocurrencies and the blockchain technology that they sit on maintain a fundamental American principle: that is individual privacy, a free marketplace, and competition with innovation. Why should the Fed focus on uplifting private crypto markets and blockchain innovation rather than crafting a CBDC that wipes out this great industry or has the potential according to Chair Powell to wipe out the industry?”
If the U.S. regulatory environment remains friendly to decentralized assets and blockchain innovators, then the issuance of a digital dollar CBDC would likely accelerate crypto economy adoption. Formally integrating fiat into the cryptoverse would allow more users to save through decentralized assets like Bitcoin while having easy access to familiar units of account such as dollars. We look forward to The Federal Reserve System’s upcoming CBDC report, and remain optimistic about the long-term outlook for digital assets being recognized fundamentally as forces for freedom. As Sarson Funds’ CMO & Cofounder Jahon Jamali put it, “Bitcoin is as American as apple pie. There’s nothing that’s more American than financial freedom, and we have an opportunity here to take the lead if we really want to grab it.”