Complement or Competitor? Stablecoins and CBDCs in the Digital Asset Universe

Stablecoins and CBDCs

Stablecoins and CBDCs

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.”

Treasury Department Evaluating a Government-Sponsored Digital Dollar

Treasury Department Exploring Use of FedCoin

According to Deputy Treasury Secretary Justin Muzinich, the Treasury department is exploring multiple possible avenues to support a central bank digital currency tied to the US dollar. The Boston Fed is taking a leading role in this exploration, partnering with MIT’s Digital Currency Initiative to evaluate more than 30 different blockchain networks to test scalability, efficiency, and ability to support US financial infrastructure.

Muzinich noted in a statement, “There are clearly efficiency benefits and cost benefits to using a distributed ledger… And I also think, more broadly, it’s important for government to embrace innovation and not be scared by it.” As Muzinich states, the US must take initiative and embrace the pace of global tech innovation, especially as China is already leading the charge.

Muzinich also noted how crucial it is for the government to begin regulating cryptocurrencies, as they offer versatile solutions to many governmental and corporate financial operations. While compliance to AML rules presents a barrier for governmental adoption of digital currencies, we believe that with the rate of innovation that the crypto ecosystem is experiencing, solutions to AML and KYC concerns are not far away.

To remain a global economic superpower, the United States must position itself along the cutting edge of financial technology, and adopting blockchain technology as the backbone of its future financial system is the most progressive, stable, and secure approach to ensuring future economic competitiveness.

By Liam McDonald

Uniswap’s “Crypto Stimulus Check” Sends Defi Market Into Frenzy

Crypto Stimulus Check Makes Investors Question Effectiveness of Government Stimulus

Weekly Analyst Thoughts

Uniswap Token’s “Crypto Stimulus Check”

Last week became a momentous week in Defi when Uniswap decided to drop 400 UNI tokens to anyone who ever used their exchange. The drop included anyone who even tried to use their DEX, even if their transaction failed. Most people in crypto are dubbing this airdrop the “crypto stimulus check,” worth roughly $1,200 when it was first airdropped, ballooning to $3,200 one day later, then finally finding price resistance around $2,000 soon after. The efficiency of this airdrop, in how it was immediately distributed to over 140,000 addresses, versus the many weeks of delays on the US government stimulus checks, is quite striking. Furthermore, Uniswap has enticed liquidity providers to contribute even more liquidity to their platform by offering four yield farming pools, pictured below.

Although the “crypto stimulus check” was an amazing development for all Defi users, the one thing it exposed is the lack of scalability on the Ethereum network, as some paid fees in excess of $60+ to turn their 400 UNI into ETH.

In summary, the “crypto stimulus check” was a pleasant surprise for Defi users, but if Uniswap wants to continue to grow into a powerhouse decentralized exchange, it must seek scalability solutions for its platform with Ethereum 2.0, considering the high Ethereum gas fees deter users from transacting on Uniswap.

By Jacob Stelter

2019: What a Year in Crypto!

New Year’s greetings! Let’s celebrate what a great 2019 it was for crypto … Don’t let the fake news convince you otherwise. 😉

Yes, prices rose and fell violently. Some people made money, and some lost. Timing was very important. But Bitcoin is higher today than this time last year by 90%. Despite the gains, Bitcoin continues to scare anyone looking to use it as a store of value… none of that is new.

What made it a great year for crypto was the explosive growth that cryptocurrency networks experienced in Asia, Europe, Africa and the United States.

The global Bitcoin network is growing in institutional circles at the fastest pace in its existence. The power of blockchain technology (and cryptocurrency, its first killer app) is catching on like wildfire all around the world.

With better regulator clarity, it shouldn’t be surprising that the pace of “crypto-normalization” is increasing. You can read our favorite highlights from 2019 below:

Growth is Booming in Asia

    • China now has nearly completed digitizing its currency and has recently enacted laws supporting Blockchain Technology and educating its citizens as to its benefits.
    • Japan’s largest bank, Mitsubishi bank offers cryptocurrency custody and trading services.
    • South Korea and Singapore are courting Cryptocurrency firms as are Malta and Liechtenstein.
    • “Blockchain” is the fastest growing job skill in Singapore, and among the top 3 in China, Japan, Taiwan, South Korea, Hong Kong and Vietnam, according to LinkedIn studies.

Growth is Booming in Europe

    • Germany trades cryptocurrencies alongside equities on exchanges.
    • In Switzerland and the UK, cryptocurrencies can now be banked for safekeeping with some of the country’s most iconic banks.
    • France is attracting Cryptocurrency focused firms with preferential tax laws.
    • The EU’s Financial Regulatory Authority FATF has issued clear anti-money laundering in the form of its “travel rule” which governs purchase and sale of “virtual assets” and requires reporting on crypto transactions greater than $1000.

Growth is Booming in the USA

    • Over 100 Fortune 500 companies announced projects related to Blockchain Technology and/or  Cryptocurrency.
    • Futures and Options on Bitcoin and other cryptocurrencies have launched and have seen rapid growth.
    •  JP Morgan Successfully launched a digital Currency.
    •  Fidelity Investments now offers Bitcoin custody and trading.
    •  A new regulatory framework is in front of congress Read about it here.

Even More Growth with Regulatory Clarity

We now have SO MUCH more clarity into the trajectory of institutional crypto adoption. We are brimming with confidence that we are on the right path. We subscribe to the adage that markets will behave like voting machines in the short-term, but like weighing machines in the long-term.

We aren’t letting the short-term price of Bitcoin or any other asset cause us to turn a blind eye to the paradigm shift that is happening right in front of us.  We foresaw many of the regulatory developments of 2019 and positioned our funds correctly (such as excluding “privacy coins” from our universe). Seeing the poor performance of the coins that we excluded has further validated our research and investment processes.

That is not to say it has been easy sledding. The MVIS CryptoCompare Digital Assets 10 Indexwhich tracks large cap cryptocurrencies (and to which we benchmark our flagship large-coin product Blockchain Momentum, LP), returned an underwhelming +9% for the year. The MVIS CryptoCompare Digital Assets 100 Small-Cap Index (the benchmark we use for our small-coin fund, Fifth Khagan, LP) fared even worse, ending down -33%.

We are happy to say that unlike our indices, both of our strategies remained positive for the year with net performance of around +45% and +15% respectively (unaudited and subject to change).

In 2019, our investment process added more than 25 percentage points of alpha on average verses our indexes. Our traders, analysts and “Blockchain Insider” group are delivering and deserve recognition. 

Other firm highlights for the year included meeting with the IMF in Washington DC, improving the client experience with Daily NAV reporting and online account access and getting a chance to sit down with our favorite financial news anchor, Maria Bartiromo to share our ideas about how blockchain technology will rebuild the world’s financial infrastructure and what has caused the United States to fall behind China in the race to shape the future of finance.

In 2019 our team welcomed one new baby, heated a pool with Bitcoin Miners, opened an office in Massachusetts and enjoyed traveling around the country sharing best practices for safe cryptocurrency investing.

We will look back fondly on 2019 but are excited for what lies ahead for cryptocurrency and blockchain in 2020. The future looks bright!