Name: Post FTX meltdown, can stablecoins provide safe harbor amid volatility?
Uploaded: 2022-12-08
Duration: 8 min 23 s
Description: Stablcoins are a $150 billion crypto asset class.

Stablcoins are a $150 billion crypto asset class.

Post FTX meltdown, can stablecoins provide safe harbor amid volatility?

Photo illustration by Fortune - Photos by Getty Images

Finance

Can stablecoins provide safe harbor amid volatility?

the most famous Cryptocurrency courses. Bitcoin millions of people own Bitcoin today. It's a new form of money. It's used around the globe and I think that's very remarkable. Its market cap has been above a trillion dollars. And then there's another species of Cryptocurrency called stable coins whose job it is to basically replicate or imitate major currencies like the US dollar or the british pound. Stable coins are crypto tokens whose values are pegged to a fiat currency or really I guess it could be to any other price. The most common type of stable coin is one that is pegged to the U. S. Dollar. The main use for stable coins right now is for people protecting themselves against volatility. And that's really what stable coins offer to people on chain. It's just the ability to get out more or less without having to go into a coin base and go all the way into a bank of accounting. There's just a lot less friction that's involved when you have everything on chain and sort of protect people from volatility. So I want to convert Bitcoin $2 and I want to put it back into my bank account that's gonna incur a delay. And so if I want to go back and trade again I may not have my funds available when I need so stable coins really emerged at the interface between more traditional finance and banking and crypto as a solution to this kind of problem. They grew tremendously as defi became more of an interesting and developed space in crypto that's another word you hear bandied about in crypto sphere a lot it's short for decentralized finance. It's basically, you know, replacing bankers and brokerages and middlemen with smart contracts so that you know you're out there trading and there's no central clearinghouse, there's no person overseeing your just interacting with these computer programs. If you want to build any sort of advanced financial contracts on top of a Cryptocurrency, well you need to often refer to a stable reference asset. Right? Imagine a simple loan where I loan from your to you in Bitcoin depending on the price moves, you either owe me a lot more or a lot less than what we agreed to. So if you want to enter into a loan agreement is extremely useful to have a stable unit of reference, like the dollar of the three main categories of stable coin. The one that is maybe the most kind of logical would be commonly called reserve backed stable coins. They have an amount in the bank that corresponds to the amount of stable coins that they've issued. So the total value of stable coins right now I believe is roughly 150 billion. And that's largely made up between us dc and tether, I think us dc and tether make up about 75% of that number. So You know, a little more than 100 million when we created tether, we did so because my partners and I were trying to trade crypto and there were always times probably at least once a week when I would get nervous about the market and I would love to go into a safe harbor that was non volatile. The only way to do that was to take the crypto. I had converted all into Bitcoin. Take the Bitcoin and transfer it to one of the few exchanges that had access to banking and then trade my Bitcoin for dollars and have those dollars wired to my bank account. And by the time that happened it took about five days and I wanted to get back in. So our thinking was what if we were in a crypto that was tokenized dollars. They can interact with crypto and you don't have to now cash out and go through all of those troubles of getting that done. Now people always say tether has some controversy because because of its lack of transparency around its holdings. I'm no longer associated with tether. I would like tether the operators of it to be more transparent to do more frequent audits and yet people still use it. It's the most traded crypto on earth. The next category that is widely used is one that is collateral backed. And so that means that it may not be backed by U. S. Dollar Or US dollar equivalent but it's backed by some other crypto acid and is over collateralized. So for instance it might be backed at a ratio of 150% meaning that the collateral you put up would have to be 150% of the dollar that you want to take out in the stable coins. And if the value of your collateral falls below that ratio then you would have to top up in order to retain the stable coins that you took out. And these kinds of stable coins tend to be more decentralized. They can be managed by smart contracts and they also are somewhat safe in the same way that reserved back ones are but they can have volatility at times. For instance, like black swan events right? When the pandemic began, there was definitely some pandemonium in the world of these types of stable coins because obviously the value of the collateral had dropped precipitously. And the rich are known as algorithmic stable coins. And those function in a way where there's a pair of coins or even like three different coins, one that is pegged to the value of the fiat currency and then the others have free floating values. Most of these frankly have failed. The most famous of all of these was an ecosystem called terra luna in economics. A bit like the laws of physics, sometimes you can defy gravity and some of these algorithmic stable coins are really clever in their engineering were very weak in their economic and market design. How did this all go wrong? And the way up as the ecosystem grows. It's all fine. There's really no problem in that initial phase and that's why people trusted these instruments without thinking too hard about the underlying economics as you mint new coins, you're essentially taking value in and putting it in the reserve in the form of this equity token. But the challenge is that whenever you get a very large redemption, think of it as a classic run on the bank, people are tired of holding the dollar denominated token and they want to get back their value maybe to spend it on goods and services or maybe because they're worried about the stability of the stable point. When that happens, the reserve finds itself into this impossible dilemma where it needs to sell more and more of the equity to meet redemption a bit like a central bank trying to cope with a massive economic crisis. When that happens, the value of that table quickly precipitates to zero because everybody's running. Everybody tries to redeem the process reinforces itself and you get what is typically called the death spiral. People lost faith in the system and so they were trying to exit and to the prices of both just collapse to zero. Maybe at one point there might come along some algorithmic stable coin that actually works and doesn't collapse in this way, but all of them so far have not met a good faith and after the collapse of Carolina, a number of people have been saying that the word stable coins should actually not even be used for those. So, regulators are focusing on stable coins probably as a whole seeing the Carolina situation and saying like, okay, you know, do we need to put some guardrails around who is allowed to make these things, what assets are allowed to back them and things like this. Stable coins have been probably the most important coins after the original token. Bitcoin have been the most important for growing the crypto ecosystem. If you consider that half of all Bitcoin trading pairs trade with tether That tether today has over $30 trillion dollars annually of trading volume. That shows you that the stable coin concept and tether in particular have been very well received people Historically, I've always wanted to have their financial lives right where they're earning their money and spending their money and that's inside of the metaverse. If you will, then they're gonna want all their assets kind of within that realm. That's where stable coins play a key role until we have a better framework and more of the protections that you've come to expect from, you know, FTSE insurance that protects you know, your dollar balances up to 250 K. Those are the kind of things that will need to come into place for stable coins to be truly useful for consumers, merchants and for global commerce