Why the ones we know will die
Stablecoins have been cryptocurrency’s solution to exchanges needing to go through onerous regulations to comply with finance laws around transmitting fiat currencies like the US Dollar. Stablecoins are cryptocurrency tokens backed by fiat currencies — almost all of them pegged to USD. Because stablecoins are thus far unregulated, cryptocurrency exchanges have a lot less red tape to deal with if they support stablecoins and don’t directly support Dollars or other national currencies on their platform. This benefits exchanges while also giving customers the functionality of having a “stable” token denominated in Dollars.
Many cryptocurrency buyers and traders keep all their non-invested crypto money in stablecoins on exchanges rather than in fiat currencies. Because fiat currencies are legacy technology and therefore not part of the more advanced cryptocurrency system, stablecoins are much more useful in the crypto market than fiat currencies. Stablecoins can be transferred between exchanges far more quickly than fiat currencies. They can also be used directly in decentralized exchanges and DeFi apps, which are entirely incompatible with legacy digital currencies.
The entire stablecoin market value is currently about $130 billion and over $100 billion in daily trading volume. There are a few dozen different ones, though only the top five to seven stablecoins are very relevant in the market. As the crypto market grows, the amount of money in stablecoins naturally grows as there will always be some amount of monetary float between trades. Stablecoins also get lent out to earn interest on various centralized and decentralized platforms, so some people simply hold them as high interest earning dollars compared to the feeble earnings you get from banks.
Despite the large market cap of stablecoins and their important use in the crypto market, there are several current and future factors that may make stablecoins obsolete in the years to come.
Government Regulation
Stablecoins are thus far unregulated, but the US government is currently working on a stablecoin regulatory scheme. This regulatory framework is expected to be released soon. Included in this framework could be a requirement that stablecoin issuers who want to be available to US customers must operate under a bank charter and comply with the sorts of regulations under which banks operate.
This would likely lead to greater government oversight over stablecoins and possibly strict dollar-backing rules. Thus far, stablecoin issuers have been pretty opaque in how they store all the fiat currency exchanged for stablecoins. This lack of transparency has led to many (conspiracy) theories in the crypto market about the backing of the market’s dominant stablecoin: Tether.
Regulations imposing transparency and requirements on how the coins are backed will be good for the market. This will lead to greater investor confidence in the market. But other rules and oversight may cause problems for the market.
If issuers are required to operate under bank regulations to service US customers, that could mean some stablecoins disappear due to not wanting to deal with all that regulatory red tape. Or they may still exist but will be cut off from the crypto powerhouse that is the United States.
Also, part of the reason why crypto users like stablecoins are for privacy reasons. Stablecoins are off the banking payment rails, and therefore not so intimately tracked by governments. But with new regulations requiring issuers to give the US government greater oversight of their businesses, stablecoin privacy will disappear as they will likely be tracked in just as much detail as fiat currencies.
Essentially, government regulation will likely soon move stablecoins under the same oversight restrictions as fiat currencies transmitters and transactions currently have. This can have both positive and negative effects. It will likely reduce the number of stablecoins out there, improve general confidence in stablecoins, but bring stablecoins under the financial control of governments and the more hardcore anti-government crypto users out there may stay away from stablecoins entirely at that point.
No difference between trusting a company vs. trusting a government
There are plenty of people in the crypto space who entirely distrust the government, and instead, they are entrusting their money to companies. But just as governments and banks can freeze your bank accounts, stablecoin issuers can do anything they want to any account in their network.
I don’t see this talked about very much, but most stablecoins are entirely centralized in that the issuers have 100% control over all the money. This isn’t any different than a government or bank having control over your money. Perhaps users believe the stablecoin issuer is far less likely to abuse power on their own network than an external entity like the government.
But this becomes a much more significant concern because of the possible regulations discussed above. Once governments have complete oversight of stablecoin issuers, they can enforce their will on these networks like they do in bank accounts. Your stablecoin account will be no safer from government abuse or mistakes than your bank account. Regulations will clarify that centralized stablecoins aren’t better than fiat currencies from a privacy and safety viewpoint.
Stablecoins are not insured
Crypto users are well aware that stablecoins don’t have FDIC insurance the way USD in banks do. So if you somehow lose some amount of money in stablecoins, there is no recourse to get it back unless you somehow got the issuing company to take direct action in your case, which seems impossibly unlikely.
The point of being in a stablecoin rather than a market-driven cryptocurrency is safety. You have money in stablecoins when you don’t want to be touching the market. Part of this idea of safety should be the security in knowing if a mistake or thief resulted in a loss of funds, you would be able to get that money back. But that is not so for stablecoins. Therefore holding your money in stablecoins always involves a little higher risk than keeping your money in fiat currencies.
Since stablecoins don’t allow you to escape the inflation of fiat currencies because they are pegged to fiat, the whole point is not that you will gain value with them but that you will keep your value safe on shorter timescales — like between trades. But because stablecoins aren’t insured, it is safer to keep money in fiat on exchanges that have fiat.
If regulations require stablecoins to be insured, then the extra cost on issuers of that insurance may further put some stablecoins out of the market.
As crypto regulation here in the US increases, exchanges operating with US customers may very well be required to adhere to regulations required to hold fiat. So every US-allowed exchange may as well have fiat at that point. This means stablecoins lose some of their value for trading. They would still, of course, be much more useful for sending funds and would be required for stablecoin lending or use in DeFi applications. But stablecoins could lose their trading utility against fiat currencies in this way.
CBDCs
Central Bank Digital Currencies (CBDC) are on the way. The CBDC concept is all about taking Bitcoin’s technological monetary upgrade and applying it to national currencies. It is the tokenization of fiat currencies. They will still be the same old fiat currencies you know and love (or hate!), but the payment rails the money operates on will be far more efficient by leveraging cryptocurrency technology.
There are greater privacy and authority concerns over CBDCs than there are for the legacy format of national currencies. CBDCs would mean central banks have direct connections to people’s bank accounts. The privacy concern is that absolutely every transaction will be tracked in a way that isn’t even done in the legacy banking system. The authority concern is that this direct control over people’s bank accounts will mean the central bank or government could directly move money in or out of one’s bank account. Even in more free nations, governments already occasionally abuse their self-given right to seizure of citizens property, but CBDCs may make that much easier to do. This could lead to more significant government abuse.
So while CBDCs will make the fiat currency banking sector far more efficient, there are also grave concerns about how it will operate. China is making bold moves to outlaw any currency that they don’t have direct and total control over, as they are already in the early stages of transitioning to using their CBDC. I would expect more free democratic nations to take a much less oppressive path than China, but there is still plenty of room for increased government abuse.
CBDCs are coming whether you like it or not, though. It is natural that the very inefficient legacy banking rails get upgraded now that Bitcoin has shown a far more efficient payments technology. Most countries are working on their own CBDCs. While CBDCs don’t present problems for deflationary, decentralized, and useful cryptocurrencies like Bitcoin, they present problems for stablecoins.
Once fiat currencies are tokenized into CBDCs, it is presumed that they will be able to operate in the crypto landscape the same way that stablecoins do. It’s always possible that government regulations will forbid CBDC accounts from directly engaging in the decentralized economy. Still, even so, CBDCs would be a direct threat to stablecoins’ role as a currency to be used in between trades and to send between exchanges. Trading is currently the primary use case for stablecoins. This means CBDCs could directly compete with the major use case of stablecoins.
Given the points above about stablecoins not being insured and not being any different from a privacy or security viewpoint than holding fiat, this could make stablecoins at least somewhat, or possibly even mostly, redundant.
How Stablecoins could survive
Not all is bleak for stablecoins. Even though regulations and CBDCs might significantly lessen the desire and need for stablecoins, there is a possibility of success in the stablecoin market: truly decentralized stablecoins.
This could take two forms: bitcoin-backed or algorithmic.
Bitcoin-backed
As far as I know, this doesn’t exist, and I haven’t personally seen anyone propose this idea. But it would be possible to create a decentralized stablecoin smart contract by allowing people to trade in bitcoin for stablecoin tokens. When bitcoin is sent to the decentralized stablecoin contract, new tokens would be issued according to the current price of Bitcoin. Likewise, people could send stablecoins back and get bitcoin according to whatever the bitcoin price is at that point.
Because Bitcoin is deflationary and will always go up in value long term, the long-term viability of this sort of stablecoin project would be secure. The only risk would be a run on the market when a significant portion of the stablecoin owners want to cash them in for bitcoin while the market is down. This would only really be a risk in a large downturn or soon after this sort of stablecoin started getting wide use. The longer this sort of stablecoin existed, the safer it would be. At some point, as Bitcoin’s price grows, it would likely attain several times the backing of the amount of the currency issued, meaning it would be ultra-safe.
Once the stablecoin is ultra-safe, the algorithm could even allow interest to be earned in lending accounts, drawing on all the extra backing from the price appreciation of Bitcoin. This would mean a robust and safe decentralized stablecoin could be built on and backed by the hardest money humanity has ever had.
Algorithmic Stablecoins
Algorithmic stablecoins are unbacked coins that stay pegged to the US Dollar price (or whatever fiat currency) by burning or increasing coin supply instead of a company holding the fiat currency for people in a bank account. Supply control is used instead of being backed by assets.
Algorithmic stablecoins already exist, but it is still early days. We don’t yet know if the peg will hold under all market conditions and long-term. There have been instances of algorithmic stablecoins swinging wildly away from the US Dollar during certain extreme market events.
But the race is on to provide a secure, decentralized, algorithmic stablecoin. If such a coin is operated in a truly decentralized way — with the founding developers or company unable to control it — that would allow it to run outside government regulations and potential abuse.
This type of stablecoin could also be made to peg to any value, not just the US Dollar or some other fiat currency. It could be pegged to another asset or a basket of assets or goods. A more stable basket of goods could be chosen for the value to peg, instead of the US Dollar, which, especially since Covid, has been being debased rather quickly.
This is likely the safest and strongest solution for stablecoins. Whether this type of stablecoin would be banned by most governments for being entirely outside their control remains to be seen. Because it would be decentralized, it wouldn’t be able to be shut down, but it could be made illegal.
Centralized stablecoins will likely become extinct this decade, and if there is a type that will survive regulations and CBDCs, it is likely a totally decentralized algorithmic stablecoin.
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