About three weeks ago, the billionaire Mark Cuban called for the regulation of so-called stablecoins, or dollar-equivalent crypto tokens. This was after he lost a significant amount of money in TITAN, a token that was used to ensure the stability of the stablecoin IRON. TITAN went from $60 to zero in under a day. The story behind that is interesting in itself, and you should read this excellent Twitter thread from Frances Coppola for more:
In this post, though, we’re going to focus on what Cuban said about stablecoins. Part of his statement to Bloomberg was
there should be regulation to define what a stable coin is and what collateralization is acceptable. Should we require $1 in us currency for every dollar or define acceptable collateralization options, like us treasuries or?
To be able to call itself a stable coin? Where collateralization is not 1 to 1, should the math of the risks have to be clearly defined for all users and approved before release? Probably given stable coins most likely need to get to hundreds of millions or more in value in order to be useful, they should have to register.”
To this, a reader and friend asked me the following:
This makes me ask the more fundamental question. Is there a way to make a reliable stablecoin but not offered by a state?
My view of this is twofold.
One, any private attempt to create an asset-backed or currency-backed stablecoin is futile.
Two, we don’t need asset backing to create a stablecoin.
Let’s talk about One: why private stablecoins are near-impossible to pull off:
Asset backed coins are always reactive to demand and supply. A dollar backed stablecoin must bring actual dollars or dollar equivalents onto their books when demand is high, and must take them off the books when demand it low. This is fundamental to maintaining the price at USD 1, but is always post-facto. This is the same whether the underlying is fiat, crypto, commodities or others. Overcapitalisation is one answer, but only in a finite band. If a stablecoin becomes popular, the surplus can quickly be eaten up. In the case of crypto backed stablecoins, a wide rise or fall in the underlying token’s price could do the same.
Fiat has no such problems because they are units of account enforced by governments. A dollar is One Dollar because the US government says so, and the US government ensures it is the only one who can say so. Dollars are not backed by anything, and nor are other fiat currencies.
Of course, there could be excess demand for money, for dollars, and the federal reserve could print more, but (and this is some simplification here) if it prints more than the economy ‘needs’, it leads to a glut, which we call inflation, which is simply that goods begin to cost more because a dollar is ‘worth’ less. But that last fact is always expressed in terms of the price of other things. A stablecoin is one such thing.
This is why the only practical fiat stablecoin is one that is issued by a government.
But that is only half the picture.
So then let’s talk about Two: whether asset backing – state-mandated fiat or otherwise – is even necessary for a stablecoin:
USDT is the most popular stablecoin. And that popularity also makes it the most interesting one – because Tether doesn’t really try hard to hide the fact that its asset backing isn’t really solid. The recent case with the state of New York required it to disclose that the vast majority of the backing was commercial paper and secured loans, not actual cash, which was under four percent. And yet there was no dip in volume, no volatility in price. It remained rock steady at USD 1.
This is because Tether serves one critical purpose: people need a crypto token equivalent of One Dollar.
Tether being early to the race set off a virtuous cycle: the more people owned it, the more other people were likely to own it, secure in the belief there were buyers for what they held. Put another way, that they could purchase other crypto tokens – ie other goods – for their USDT, and it would be measured in something familiar, dollars.
Tether had created Fiat.
As the fintech commentator Patrick McKenzie wrote, although far less admiringly,
At this stage, at this volume, Tether’s price is anchored in the widespread belief that it represents One Dollar.
That’s it. Not in the authenticity of its auditors’ report, not in the reputation of its founders.
PS Tether isn’t the only dollar stablecoin. Other major ones are Coinbase and Circle’s USDC, Binance’s BUSD and MakerDAO’s DAI, which together have a market cap of well over $100 billion as I write this. But Tether does represent over 60% of that.
So to conclude.
Yes, an asset-backed stablecoin is only practical when it is issued by the same entity that issues the asset itself, ie a government.
But being backed by an asset isn’t a prerequisite for a stablecoin when it becomes so popular it behaves like its own unit of account.
Apparently it is, in practice, possible to create a private dollar based on faith. That said, I find it hard to imagine how this party can last much longer for Tether. We shall see.