Author: Rahul

Readers, recently an acquaintance – who has been following the crypto scene for some time but has not yet dipped their toes in – asked me about Central Bank Digital Currencies (among other things).

I ended up writing a somewhat broad sweep of the state of Central Bank Digital Currencies.

I think you might find this an interesting weekend read.

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Since the first major regulatory interventions into the cryptocurrency space around 2016–17, governments have talked about central bank digital currencies.

India’s central bank, the RBI, has since 2018 hinted about a digital rupee. In July, it even said it planned a phased rollout – although once again without any timeline.

The European Union has been more detailed about its approach to a possible digital euro. Later this year, it plans to start a two year investigation into the design, organisation and rollout. It has explicitly stated it won’t be a ‘crypto asset’, that the ECB will be the custodian of any such currency, and that it will complement cash.

China has had the most broad rollout of any central bank digital currency anywhere. It has run pilots across cities from 2020, and recent examples have shown that it is, in some ways at least, programmable in that specific e-yuan tokens can be used for specific purposes.

Mark Carney, the governor of the Bank of England, has talked previously about a global digital reserve currency, instead of each country issuing its own.

Central Bank Digital Currencies, as major economies have described them, differ significantly from cryptocurrencies like bitcoin. They are not really decentralised, because only authorised entities can run nodes on the blockchain. Tokens can only be custodied in wallets run by government-regulated entities, as with China’s e-yuan pilot. They are also likely to be backed 1:1 with actual currency (whose supply is controlled by the very central bank that issues the Digital Currency).

This is unlike even asset-backed private stablecoins like USDC, which have to either over-collateralise reserves or maintain a mix of cash and short-term deposits.

Even so, they do have potential to improve upon the digital nature of most currencies today:

One of the biggest issues with payments today is settlement. Movement of information is instantaneous, movement of money takes days. When I pay my mobile phone bill online via my debit card, the payment gateway tells Airtel (my cellphone carrier) to mark my account as paid right away, but the actual movement from my bank to the payment gateway’s central account to the carrier’s account takes about three days, delayed by weekends and bank holidays and subject to daily ‘cutoff’ times. With digital tokens, information and money can be made part of the same payload. If I were to pay the same bill with my CBDC wallet, the payment gateway could debit tokens from the wallet, mark them with my mobile number, and credit it to Airtel’s account instantly. Airtel now has both the money and the customer ID because now money not only moves instantly but carries information with it.

This was so powerful a concept that back in 2015 Goldman Sachs applied for, and in 2017 received, a patent on such a use case, which it termed setlcoin.

It was also what the company Ripple had attempted to do with cross-border transactions. Its XRP token was meant to obviate the need for nostro accounts, with foreign currency kept idle in overseas branches of banks across the world to settle payments made in one currency into the other. (Unfortunately for Ripple, the USA SEC charged the company with an ‘unregistered securities sale’, alleging that its sale of XRP to retail investors violated regulations.).

Settlement is an elementary example of the basic characteristic of a currency based on digital tokens – its programmability. Blockchains can host and execute code that manipulates tokens between wallets based on data that is either on the blockchain itself, or fetched from some other real-world source. The Ethereum blockchain, which was built for such programmability, terms these smart contracts. About a year ago, I wrote a blog post, split into four parts, on what programmable money could do, including collating several examples from other articles: (Part one, two, three, four).

One aspect of programmable money is of course giving banks and governments more fine-grained control over what capabilities money itself has. Instead of placing limitations on the account, it could do that to the very cash held in that account. If the government wanted to freeze funds for an individual, it could simply invalidate all tokens that, according to the blockchain, were currently held by the individual, regardless of what wallet or bank account they were in. Transactions on the bitcoin and other blockchains are already traceable, but are essentially anonymous. When they are tied to national IDs or other identifiers, they are much more easily trackable because an authority needn’t subpoena multiple banks and financial institutions – it could simply travel along its own blockchain.

There are positive use cases for programmable CBDCs as well. Governments can nudge responsible use of subsidies or stimulus money by whitelisting what it could be used for. The Indian e-RUPI, a form of electronic vouchers, is money tied to specific ‘merchants’ that it can be spent at. With a CBDC, that can be built into money itself (the industry jargon is ‘colouring money’). Another example of this is the one from China at the beginning of this email.

By building interest into tokenised money, CBDCs wallets can earn differential interest depending on what the money is used for, rather than what account it lies in. For example – to use Indian banking terms – money in a savings bank account earns minimal interest; locked up in a fixed deposit it earns slightly more; moved into a liquid fund somewhat more. But these are completely separate from what the deposits are used for. In an alternate future, banks – and governments – could display actual projects (infrastructure, social, environmental, commercial) or baskets of projects with interest rates that each of these pay out. This is somewhat like staking tokens in the DeFi space, and could dramatically simplify the complicated and opaque process of many types of bond issuances today by cutting away middlemen institutions.

Banks and financial institutions can also encourage responsible financial behaviour by, for instance, getting customers’ consent and tagging a fraction of their deposits as their Emergency Fund. Today banks can implement this in their internet banking software too, but it’s a software layer on top of money, as opposed to being built into cash itself. If the Emergency Fund smart contract was implemented across banks, a customer could transfer money from one bank to another and still have it marked as emergency in the other account.

In the same way today a physical wallet has notes of different denominations, a digital wallet will likely have tokens of different capabilities.

There are other programmable use cases for businesses, including multi-signature contracts that could establish joint ownership of money tokens, that require the consent of more than one party to be spent. This could obviate the need for cash to be locked up in escrow accounts.

There are implications for tax collection. When the context of every movement of money is known, smart contracts can deduct tax in transit. At its extreme, tax collection could be baked into the flow of economy, no longer the responsibility of individuals or businesses, who could claim credit for tax breaks post-facto every quarter or year. The savings in time could be tremendous.

In any case, central banks, through governments, are likely to aggressively preserve their monopoly on digital currencies. Facebook’s announcement of their quasi-digital-currency Libra in 2019 met with immediate resistance from the USA government, with senators discouraging the CEOs of Visa, Mastercard and other major initial participants from associating themselves with the project. The text of the letter is noteworthy for the level of alarm and the breadth of its attack on Facebook. Facebook has since launched Diem, a re-branded digital currency, seeking Swiss jurisdiction. More recently, the USA SEC chairman Gensler, made it clear in a public speech just last month in July that he intended to seek regulation of all sorts of stablecoins, whether backed directly by cash, or structured as derivative contracts.

In sum, I think CBDCs aren’t cryptocurrencies and they aren’t ‘stablecoins’. But they are – potentially – dramatically different from today’s digitised fiat currency. Issuing money as tokens on a blockchain (however centralised that blockchain may be) creates programmable money, reusing primitives, practices and technology from the DeFI space.

Many of the use cases above never be implemented. Some of them may take years to come to pass. Digital literacy, and financial literacy are perhaps the biggest challenge of all.

But the model, to me, seems to be inevitable. And something I cautiously look forward to.

(ends)

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15 August this year also marked the 50th anniversary of the ending of the ‘gold standard’. The gold standard, or the Bretton Woods system, was a World War II era system of monetary policy among primarily Western countries that required – among other things – that currency be backed by holdings of physical gold, and that the USA dollar be the reserve currency.

In 1971, the USA unilaterally backed out of the agreement, and Bretton Woods in effect collapsed. Currencies were no longer bound to anything, and not bound by anything other than the confidence of the public. 1971 marked the beginning of our era of floating exchange rates. The economic power of the USA ensured that its dollar remained the world’s reserve currency.

An immediate outcome of the collapse of the gold standard was the freedom for central banks to create ‘new’ money, untethered by the need to have additional gold reserves. Countries across the world have taken since advantage of this. The USA in particular has printed massive amounts of money. First in the wake of the 2008 financial crisis & subsequent years through the Federal Reserve’s practice of ‘quantitative easing’, and then most recently in 2020 to fund Covid relief.

Consequently, this is what the USA’s M1 money supply looked like. M1 is the total of cash and short term deposits in a country’s economy:

The following is extremely simplified but the basic argument remains:

The number of US dollars has fluctuated wildly since the end of the gold standard. And it hasn’t corresponded with a global, or even national, demand for those US dollars – instead it’s been used as a tool to grease the wheels of the USA economy. In other words, it’s been push more than pull. So you’d expect the US dollar to become less valuable as so much more of it is created.

Well, the US dollar is also the world’s reserve currency. One US dollar is one US dollar no matter what. It is other currencies that become more or less attractive compared to the dollar [1]. And because of the outsize influence of the US economy on other economies, that change is usually range-bound.

So that’s where we are today. Currencies aren’t tied to anything. And the US Federal Reserve can create arbitrarily large amounts of money without affecting the value of the US dollar because the US dollar is what everything else is measured in. That provides stability at the cost of completely de-linking demand for the dollar from the supply of the dollar, providing a unique advantage to the USA.

Enter Bitcoin.

Bitcoin has no central authority that can change the rate of issuance. The total Bitcoin supply is capped and its rate of creation is pre-defined, in code.That means no institution or government can intervene to increase or decrease the Bitcoin supply in the market no matter what the moral or economic argument. It’s simply code running on millions of interconnected computers that cannot be practically tampered with.

Therefore, the price of Bitcoin on any day closely corresponds to the actual demand for it. That demand fluctuates greatly, and that is reflected in the volatility of Bitcoin’s price:

What many discussions miss is that the demand for the US dollar also fluctuates, [2] but the US dollar is denominated in US dollars – 1 USD being worth, after all, 1 USD. That gives the impression of the US dollar being somehow infallible and rock solid. But it’s only as solid as the US economy is. That’s fine as long as the US economy thrives, and it’s ok for any individual, country, institution or entity whose interests are tied to the USA’s. But for any such entity, that’s a pretty big economic and political risk.

Bitcoin does not suffer from such risks because it doesn’t depend on any one economy. It is truly native to the internet [3]. It will survive the ups and downs of the US economy. In the future we may reach a consensus to dominate it in terms of some other post-dollar fiat currency, say the Chinese yuan. But Bitcoin’s price will still reflect its demand, and it cannot be artificially propped up or depressed by printing more or less of it [4].

Compare the wild issuance of US dollars in the M1 chart earlier with this chart of total circulating Bitcoin:

The price volatility of Bitcoin is a feature, not a flaw. Put more bluntly, the price stability of the US dollar (and potentially some future reserve currency) is a flaw, not a feature.

And that, readers, is the purest argument for Bitcoin, one that drove its creation as an alternate, internet-native system of money:

Bitcoin is independent of country, geography, economic system, ideology or political party, independent of a mediator, and independent of its denomination in terms of fiat currency, gold or in itself. It is as neutral and decentralised as the Internet is.

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[1] That discussion is international. Domestically, as a central bank, if you make a lot of money available, typically more people get easier loans to buy more things, ultimately causing money to become less valuable (because it’s more abundant). That leads to inflation. The USA has, until recently, been able to avoid inflation even during the years of quantitative easing. Critics of QE say that this is because not enough of this newly created money has found its way back to the everyman and everywoman and has remained concentrated in the hands of a few institutions. That’s a whole other topic.

[2] There exists a robust currency speculation market for many different pairs, including of currencies against the US dollar (e.g. the euro <> US dollar). But that doesn’t change the fact that it’s in effect the euro’s price in dollars that’s changing, given that the dollar is the reference.

[3] This is also true of other massively decentralised tokens, including other major cryptocurrencies.

[4] Note that this discussion is about the design of the Bitcoin monetary system versus today’s fiat currency monetary system. There are issues with Bitcoin’s current dynamics: how decentralised it really is, the rising cost of equipment to mine Bitcoin and therefore participate in operation of the monetary system, the costs of actually transferring Bitcoin from one entity to another, how democratic the Bitcoin core committee is, among others. But these are implementation issues, many of which have gotten better over time; they are not fundamental flaws in the design of Bitcoin.

There’s a provision relating to cryptocurrency in the multi-trillion dollar US Infrastructure bill that’s making its way through the USA Congress. 

It’s rather important because it dramatically expands the definition of who is a ‘broker’ and therefore who bears responsibility for performing customer KYC as per the country’s IRS requirements. 

Specifically, in the bill, a broker is now also

“any person who (for consideration) is responsible for and regularly provides any service effectuating transfers of digital assets.”

This Twitter thread does an excellent job discussing the implications of this move, including how it’s impossible for some entities, like crypto miners, to comply. And how it’ll probably drive entire areas of the crypto industry out of the USA:

1/ 🚨 Here's the deal with the US infrastructure bill:

A new provision has been added that expands the Tax Code's definition of "broker" to capture nearly everyone in crypto, including non-custodial actors like miners, forcing them all to KYC users.

This is not a drill 👇

— Jake Chervinsky (@jchervinsky) July 30, 2021

Banishment or surveillance?

The Electronic Frontier Foundation, an advocate of people’s digital rights, makes the case that this provision in the bill expands the government’s surveillance, making it difficult to even write smart contracts, a central feature of Decentralised Finance/DeFi:

The bill could also create uncertainty about the ability to conduct cryptocurrency transactions directly with others, via open source code (e.g. smart contracts and decentralized exchanges), while remaining anonymous. The ability to transact directly with others anonymously is fundamental to civil liberties, as financial records provide an intimate window into a person’s life… This poor drafting appears to be yet another example of lawmakers failing to understand the underlying technology used by cryptocurrencies.

Then, nearly every thread on Twitter that reports these crypto provisions has commentators stating it is no accident that these provisions will cause crypto companies in the USA to move overseas, that the threat of crypto to the US dollar and to the existing financial services industry is large enough now that exile is preferable to coexistence.

Now. 

There’s been sufficient discussion of this online that, as of this writing, there’s been pushback from at least three senators, who have proposed an amendment:

The update, filed by Sens. Ron Wyden, D-Ore.; Pat Toomey, R-Pa.; and Cynthia Lummis, R-Wyo. would specifically ensure the term “broker” excludes validators, hardware and software makers and protocol developers.

We don’t know yet whether this amendment will make its way into the final bill. 

But it’s not enough. Here’s an example.

Decentralised exchanges – in or out?

Even with these exclusions, several parts of the crypto industry remain under threat, not least decentralised exchanges, or DEXes. 

At a decentralised exchange, ‘you are your own brokerage account’, just like with a Bitcoin wallet, ‘you are your own bank’. There is no equivalent in the ‘real’ financial industry:

You don’t sign up and create an account at a DEX. The DEX doesn’t maintain a user registry and manage passwords. You connect an existing crypto wallet to the DEX to be able to buy and sell. When you buy, tokens are moved into your wallet from the wallet of someone else connected to the exchange. When you sell, they’re sent from your wallet to someone’s. See these screenshots for the DEXes Uniswap, dYdX and Hashflow:

You see there’s a ‘Connect Wallet’ button on each of these exchanges instead of ‘Sign up now’ or ‘Existing user? Login’ buttons. DEXes don’t need to bother with identity, and so they don’t. All the DEX does, at its core, is figure out demand and supply for a set of cryptocurrency pairs. 

But this is incompatible with how the USA Congress views things. See this tweet from the senator who’s the Republicans’ chief interlocutor on the Infra bill:

The infrastructure bill includes a provision that helps accomplish that goal. It standardizes information reporting by crypto-brokers to the IRS for tax purposes – the same way it’s done for stock trades.

This will make it easier for folks to determine & pay their tax bill.

— Rob Portman (@robportmanOH) August 3, 2021

This works for centralised crypto exchanges like Binance, Coinbase, Kraken, Gemini and several others, which are modelled on traditional stock exchanges, just that they trade crypto instead of stocks and ETFs. But it doesn’t translate to the decentralised exchanges we discussed, and even the senators who proposed an amendment to ostensibly bring some sanity to the crypto provisions in the bill – even those senators don’t get it.

To conclude: this is all rather ham-handed

Over all, the whole episode is a clumsy way to handle what part of the crypto industry should be subject to regulatory oversight, what activities should be taxed and how, and what should be disallowed. 

Even the reason that the crypto provision is part of the bill is because infra investments need to be ‘revenue neutral’, that is, it needs to state clearly where the money to pay for infra is going to come from. To that end, the bill makes the assumption the crypto industry will contribute USD 28 billion in additional revenue through taxes, which will be used to fund national infrastructure projects. 

The implication here of course is that there is a large amount of tax avoidance taking place – specifically, USD 28 billion over the next few years, and therefore greater oversight must be enforced. 

Whether or not there’s tax avoidance in the crypto industry today, what that looks like, and how it needs to be plugged should really not be discussed in the context of a bill that deals with roads, bridges, ports and airports, EVs and the like – not least given that regulatory bodies and the USA government – the SEC, the Treasury Department and the Commodity Futures Trading Commission – are all working on their own regulations.

It’s unlikely that lawmakers will drop crypto altogether from the bill – it’s too far gone for anything other than small compromises. Like it or not, right or not, this is going to be the first major systemic regulation of the crypto industry in the USA.

(ends)

Wealthfront customers in the USA 🇺🇸 can now expose up to 10% of their portfolios to crypto by investing in Bitcoin and Ethereum trusts (which hold the actual crypto).

The celebratory headline image on Wealthfront’s blog post

Wealthfront says

Buying cryptocurrency can feel intimidating — it takes time and effort to research all of the options, set up a wallet, and monitor an additional account. That’s why we’ve made it easy to get exposure to Bitcoin and Ethereum right in your Wealthfront portfolio, no wallets required. Instead of buying coins yourself, you can invest in GBTC and ETHE.

I think Wealthfront finally decided that it needed to offer crypto to be competitive in the wealth management space. But while it has made it convenient, offering well-established crypto trusts instead of direct access to a crypto exchange, it has also built in caution through the 10% allocation cap.

In any case, this is a big move – Wealthfront has become a mainstream money manager with nearly half a million customers with assets of about USD 25 billion. Its main rival Betterment, which manages about USD 30 billion, has also said it is seriously planning to add crypto. On the brokerages Charles Schwab and Fidelity, customers can buy into the same Bitcoin and Ethereum trusts from Grayscale that Wealthfront offers. 

Add to that crypto in PayPal, Venmo, Square and Robinhood, and you can see how if you’re an investor in the US, it’s super easy to get direct exposure to cryptocurrency without actually buying crypto tokens. 

As we’ve examined several times on this newsletter, the convenience of buying and selling crypto via these apps comes with some serious downsides. Most seriously that you don’t own these tokens yourself – because another institution holds them on your behalf – defeating the whole point of ‘you are your own bank’.

In the end, though, this rapid mainstream-isation of cryptocurrency makes it less and less likely that regulators will ban or severely hobble its ownership. We will, though, examine one serious threat soon.

(ends)

The venture capitalist Fred Wilson makes an important distinction between dollar stablecoins like Tether/USDT, Circles’s USDC, Synthetix’s sUSD on the one hand, and Central Bank Digital Currencies like the proposed US government-issued digital dollar (or China’s e-yuan) on the other. He says

“But there is another more important reason to want stablecoins to win over CBDCs – competition.”

“When you have competition, you get innovation, new features, composability, and a host of other important benefits. When you have a monopoly, like the US Government or any government, pushing out the alternatives and forcing us to use their digital dollar, you lose all the value of competition. And that would be a terrible thing.”

– Stablecoins vs CBDCs, AVC.com

Wilson’s post highlights something fascinating that is already happening:

For the first time in history there is a distinction between the imposition of a fiat currency like the dollar – which only governments can do – and coins based on that fiat currency.

Imagine the Indian government creating the rupee standard, and many companies issuing competing rupees with different properties but the same value – this is already happening with the dollar! [1]

Why would people want a coin/token that represents a currency but that isn’t issued by a government? In a word, Programmability.

Several months ago, I had imagined what new things become possible when you can program processes, checks and balances, and automation into money itself (“China and Programmable Money“). Here is an example of loans:

Each… lender implements its own loan accounting system that’s tied to it. This is why transferring a loan between two lenders, or between two borrowers is cumbersome. With programmable money, either a lender or a third-party could create credit tokens that represent aspects of a loan: interest rate, lock-in, transferability, a claim on other (similarly digitised and programmable) securities, and so on. Buying and selling loans, combining them, trading them could become a lot simpler.

Since then, it’s become clear that China’s digital currency will in fact be programmable to some degree (“China’s new digital yuan test shows it can be programed to confine utility“) – the government is programming specific public use cases into the digital yuan.

… instead of issuing free digital yuan to lucky citizens that they can use wherever the e-CNY payment is supported, the latest test comes with a theme called “low carbon summer transportation” that gives away the e-CNY as allowances to encourage citizens to take more public transportations. As such, the free e-CNY will arrive with a pre-programed utility for paying for subway and bus tickets through Chengdu’s Tianfutong mobile app or for shared bikes on the Meituan mobile app…. But it appears users won’t be able to convert the values of the e-CNY coupons for taking rides into the general purpose e-CNY stored in their digital yuan wallets.

So then. The government is one entity that can program money. Private and public companies could do likewise. Individual people will be able to program money – I could lend money to a friend under specific conditions that are relevant to only them and me. Ultimately there’ll be hundreds of thousands – if not millions – of such programs written for digital money.

Instead of having a single currency token then, say the digital rupee, whose roadmap alone determines what can be built on it, India could have multiple rupee tokens issued by different public and private entities. They are each valued at one token = one rupee. But they are branded differently and they’re optimised for different sorts of use cases. The only thing these entities cannot do is unconstrained issuance. Asset-backed stablecoins should be audited to prove they have enough reserves, and synthetic rupee providers will need to reference the right source, or oracle, for day to day (minute to minute?) rupee value.

This already exists in a clumsy way with prepaid wallets. They are essentially branded tokens that are asset-backed and have closed use-cases. But they are completely vertically siloed. Everything I do with my Amazon Pay balance has to be inside Amazon, and likewise for Paytm. There’s no single wallet where I can view my ‘Rupee’ balance, my Amazon Pay balance and my Mobikwik balance. There is no exchange where I can convert between them. The use cases are severly limited, mostly tied to e-commerce. The overhead to create and issue one’s own prepaid currency is extremely high, so there are just a handful of such branded rupees.

Natively digital programmable money can blow this ecosystem open, like the use cases above and in my blog post on programmable money, making it more valuable for everyone – not least incumbents like Paytm and even Fastag.

It’s unlikely that the Chinese government will look kindly on private issuance of different types of e-yuans. But as the Indian government and central bank look to pilot their own digital currency, they should not only build programmability deeply into it, they should also allow for similar issuance of dozens, hundreds of branded rupees by anyone who wants to [2].

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Footnotes:
(1) It looks like stablecoins will be heavily regulated in the USA rather soon)

(2) The Indian government today also heavily restricts foreign ownership of currency. If such rupee tokens are tradable, it becomes a lot more difficult to restrict their ownership. But whether the government should be more liberal about issues like this, or even the free float of the rupee’s value, is another rabbit-hole with strong pro and cons that’s way out of the scope of this site.

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:

Seems TITAN has just re-enacted the Weimar hyperinflation. https://t.co/BIGLAXRg7L

— Frances 'Cassandra' Coppola (@Frances_Coppola) June 17, 2021

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,

It’s wild to read stablecoin marketing collateral about “capital efficiency”, where they’ve managed somehow realize that with a combination of pooled equity, maturity transformation, and a loan book you can create both utility and money, but not realize that that’s a bank.

— Patrick McKenzie (@patio11) June 17, 2021

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.

The Financial Times explored the rise in crypto ransoming and crypto money laundering – how ransoms paid in cryptocurrency are converted by criminals into hard cash.

Earlier, says the FT, it used to be possible to simply ‘cash out’, that is, sell cryptocurrency for some local currency. For example a criminal in India who was paid in Bitcoin could use – years ago – an exchange to sell Bitcoin for Indian Rupees, then have those Rupees sent to their Indian bank account:

between 2011 and 2019, major exchanges helped cash out between 60 per cent to 80 per cent of bitcoin transactions from known bad actors.

But now every major exchange in India and across the world require that customers prove their identity (ie a “KYC”) before they’re allowed to withdraw money. 

It’s easier than ever now to identify suspicious behaviour: deposits of crypto followed by a sale into local currency followed by a cash-out. And to tie them to identifiable individuals.

What can criminals do? Well,

• ~ They can use exchanges that don’t require KYC. But “such exchanges tend to have lower liquidity, making it harder for criminals to transfer crypto into fiat currencies.”
• ~ They can use “over-the-counter brokers”, also described in the article as “treasure men”, who will “bury it underground or hide it behind a bush, and they’ll tell you the coordinates. There’s a whole profession.”
• ~ They can use similar middlemen who can exchange crypto for “gift vouchers, prepaid debit cards or iTunes vouchers”. These middlemen can be found on the ‘dark web’ Tor network

The article also explores how authorities can trace crypto ransoms even if they can’t identify the person holding it. But criminals can combat that too:

• ~ They can “chain-hop” between different cryptocurrencies
• ~ They can use privacy-centric cryptocurrencies that are inherently hard to trace
• ~ More interestingly, they can ‘tumble’ cryptocurrency, “mix up illicit funds with clean crypto before redistributing them” using services set up to do just that.

So. Bitcoin and crypto laundering is at least as involved and exciting as money laundering with regular, fiat currency. I think the FT article is a good introduction.

Big one: El Salvador makes Bitcoin an official currency (along with its current one, the US dollar). Interestingly, the president said it would make remittances to the country from its expatriates easier – most other countries see cryptocurrency as a way for money to leave the country. Here is Bloomberg on the news.

Moneycontrol, the Indian business website, has a profile of the Indian founder of Polygon, a project to ‘scale’ decentralised applications written on the Ethereum blockchain. In the Indian press, Polygon is an example of an Indian crypto success story.

Indian authorities launched an investigation into WazirX, a prominent Indian crypto exchange, over allegations of money laundering. Specifically, that Chinese nationals had converted the proceeds from online betting apps into cryptocurrency and then moved them out of WazirX into a foreign crypto exchange.

One of the most popular decentralised finance products is to earn interest and rewards through what is called ‘staking.’

Here are a couple of screenshots of interest rates that the Binance crypto exchange offers on staking a variety of tokens:

And rewards available on dedicated staking services like the clearly-named StakingRewards:

Given how attractive these interest rates may seem, I think it’s important to understand how staking your crypto holdings works, and what the risks are.

Here’s the crypto company Coinbase describing staking:

Staking is the process of actively participating in transaction validation (similar to mining) on a proof-of-stake (PoS) blockchain. On these blockchains, anyone with a minimum-required balance of a specific cryptocurrency can validate transactions and earn Staking rewards

a node deposits that amount of cryptocurrency into the network as a stake (similar to a security deposit).
The size of a stake is directly proportional to the chances of that node being chosen to forge the next block. 
If the node successfully creates a block, the validator receives a reward, similar to how a miner is rewarded in proof-of-work chains.

So, if you hold a set of crypto tokens that are on proof-of-stake blockchain, you can choose to ‘stake’ them and earn interest while also retaining ownership of them. Sort of like fixed deposit meets mutual fund.

Staking pools

Since it’s usually not worth an individual’s time doing this on their own, staking pools have emerged, like the examples we saw above. They aggregate crypto tokens from a large number of people and stake them as one.

As we’ve read, that increases the changes of being chosen as a transaction validation, and therefore of a reward. More such staking pools means more strong nodes, and – to an extent – a more secure network.

Aggregating also means there’s some flexibility in individuals depositing and withdrawing their crypto because there are others to fill in.

But there are risks:
For one, the service you’re using for staking could impose a certain lock-in period (or it could be inherent to the token’s blockchain), you won’t be able to sell your tokens during that period if you want to cash in, or if you want to get out.

Second, you’re effectively handing over ownership of your tokens to a third party to stake on your behalf. You’ll need to do your due diligence about that entity’s reliability: could it usurp my tokens? could it be hacked and my tokens stolen? are the rewards transparent (ie are there hidden fees?)

So. Crypto staking is one way to hold tokens for potential gain in price as well as earn interest on them, often at very attractive rates. Given that it’s all unregulated, beware of the risks and do your homework on who you stake with.

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(As always, none of the entities mentioned in this post are recommendations.)

A newly-popular cryptocurrency has been blamed for disrupting global supply chains of solid-state drives or SSDs.

The Chia network, with its Chia token, was founded as an eco-friendly alternative to Bitcoin’s energy-intensive proof-of-work mining algorithm. 

Instead, Chia uses what it calls proof of space and time, using empty computer storage to store ‘plots’, or files that are later ‘harvested’ as part of the ‘farming’ process when verifying transactions to add to the Chia blockchain.

As Chia’s FAQ describes it,

“Users of the Chia blockchain will ‘seed’ unused space on their hard-disk drive by installing software which stores a collection of cryptographic numbers on the disk into ‘plots’. These users are called ‘farmers’. When the blockchain broadcasts a challenge for the next block, farmers can scan their plots to see if they have the hash that is closest to the challenge,”

But as with anything that gains popularity, there have been unintended consequences. Since SSDs are faster than regular spinning-disk hard disk drives (like those typically found in desktops), farmers of Chia coins use setups with a lot of inexpensive SSDs. However, 

…plotting Chia uses loads of writes, so a cheap 512GB SSD can be trashed in 40 days… a higher capacity drive featuring a similar DWPD rating would have lasted longer, for about 160 days.

from Tom’s Hardware.

In fact, so many hard drives have been used and trashed that demand for them has gone up. From a Barron’s article in May:

… more than 8 exabytes of storage had been allocated to the Chia network, an increase of more than 2,000% in a month… The extra demand is spurring price increases, too: Mohan notes that the price of 14-terabyte drives on Amazon has increased between 73% and 75% in recent weeks, with 16 TB drives up between 53% and 61%

and, as the article notes, that’s been pushing the stock of hard drive manufacturers up. This is the one year trend for Seagate and Western Digital:

Finally, ironically, none of this has had much of an effect on the price of the Chia token at all:

This is one case where you’re better off investing in the ecosystem of companies around the token than the token itself!