Should You Give Up on the Crypto Dream?

Imagine an asset that’s a store of value, medium of exchange and unit of account, all in one.

Not all that tough. The NZD satisfies all of the above.

OK, then also imagine this asset is digitally transferable without the use of banks or financial middle men. OK, so now we’re talking about bitcoin?

Not really.

To many, bitcoin is not an effective store of value or unit of account. And it should be easy to reason why…it’s crazy volatile.

Had you pushed your savings into bitcoin late last year, chances are you’re not a happy saver in 2018. Maybe your fortunes will turn around.

Even if they did, it still wouldn’t help bitcoin become a global currency.

 

Can cryptos really become stable?

It doesn’t help much if you make a 20% return if the asset you receive upon sales falls by the same amount. That’s why currency should be relatively stable, rather than assets to speculate on. That way, savers and investors can plan for the future with some certainty.

That’s not to say all fiat currency is stable. Just take a look at the Venezuelan Bolivar.

Venezuelan Bolivar

Source: Focus Economics

[Click to open new window]

It once took a couple of Bolivar to buy a single US dollar. Now it takes hundreds of thousands to buy the same US dollar.

For the most part however, fiat money is pretty stable. The Aussie dollar, for example, is down 7.4% on the US dollar this year. Not ideal, but it beats the Bolivar and bitcoin for stability.

OK, so bitcoin and other cryptos are not stable stores of value now, but will they ever be? I’m hopeful they will be…someday.

Right now there are over 50 projects trying to make this a reality. Maybe you’ve heard of these new coins before. They’re called stablecoins.

When you break it down, stablecoins are a lot like fiat money. It’s a medium of exchange backed by assets. In this case however, the currency is digital and it can be backed by physical assets, like gold and the Aussie dollar or a virtual asset, like an algorithm.

Just as cash used to be ultimately backed by gold reserves in a central bank, reserve-backed stablecoins are backed one-for-one by reserves of the currencies they are pegged to,’ the Australian Financial Review explains.

Issuers of coins like USDC or Tether “tokenise” dollars by exchanging them for a stablecoin and depositing the dollars in a bank. Those dollars are then left untouched until somebody redeems the stablecoin for the dollars. It’s this confidence that the stablecoin can be redeemed that maintains the price peg.

Stablecoins backed by algorithms try and match supply and demand, pegging the coin to the AUD for example, through software.

As demand for an algorithmic stablecoin increases, supply also has to increase to make sure there’s not an appreciation in the value of the stablecoin,’ Blockchain’s head of research, Garrick Hileman said.

At the same time, as the value decreases, there needs to be a mechanism by which supply can be reduced again to try and bring the price of the stablecoin back to the peg. That’s really the class of stablecoins that are much more challenging to design. They’re really unproven at this point.

The big advantage of either design is the removal of financial middle men of course. Just like brokerage costs when buying shares, transferring, exchanging and even receiving money bears cost.

Transferring money overseas, for example can costs up to $500 in some cases. You might even be asked to pay a percentage fee, usually between 0.5–3.9%. There’s also usually a limit on the amount you can transfer.

Not so with cryptos.

These digital coins allow you to transfer as much as you want to whomever you like, sans transactions fees. That is, if you don’t consider the fee miners take to validate and etch your transaction into the blockchain a fee.

For this aspect alone people in China, Iran and even the US are using bitcoin to get money out of the country. It’s cheaper, faster and can work around restrictions.

This might not sound like such a big deal. Global transaction fees of about 7.45%  don’t seem ridiculous on an individual level. But add up the billions of individual and business transactions daily…stablecoins start to look like a god send.

Not only is it cheaper for you to send and receive money. The corporate world can effectively claw back the billions they spend on transaction fees. Profits will likely be higher, and stocks could rise. All thanks to stablecoins.

Maybe I’m getting ahead of myself. Most of these coins are still in development. Those that you can buy and sell today, Tether for example, only has daily volume of about US$3 billion.

It might sound like a lot, but it’s a drop in the bucket for the foreign exchange market, which shows daily trade volume worth trillions!

And according to one crypto entrepreneur, it’s not the only reason stablecoins are doomed to fail.

 

Are stablecoins a waste of time?

Monax founder Preston Byrne compares cryptos like Ethereum to an angry rhinoceros experiencing heroin withdrawal.

Byrne’s company was one of the first to open-source permissioned blockchain clients back in 2014. This chain soon evolved into the Hyperledger Burrow blockchain client. Safe to say he knows a thing or two about the crypto world.

And he believe stablecoins stink!

In a blog post, Byrne said Basecoin (a stablecoin project) is like the Ravenous Bugblatter Beast in Hitchhiker’s Guide to the Galaxy.

‘[It’s a] creature known not only for being extremely vicious and hungry, but also for being denser than a neutron star. Which, for those of us not versed in stellar physics, is very dense indeed. In that series of books, the Traalbeast is regarded as the single dumbest creature in the entire universe, a failure of evolution so complete and irredeemable that it “believes if you can’t see it, it can’t see you.

It’s thus with this pernicious idea of the stable coin: a free-floating digital commodity devoid of intrinsic value that doesn’t assume the market prices it, but rather that it prices for the market, and which only works by devouring new investment money at every available opportunity.

Then in a later post he rips on another stablecoin project, MakerDAO.

Having taken fifteen minutes to review the MakerDAO paper, the Dai system is at its core a very simple cryptocurrency-collateralised derivative contract, with a lot of intermediate steps to confuse its buyers of the facts that (a) that contract is massively over collateralized in the underlying cryptocurrency (which is Ethereum by default) and (b) in the event of an Ethereum black swan event the value of the underlying collateral, and therefore the value of the stablecoin, will also be wiped out.

‘…The system also assumes that over collateralising will protect the value of the Dai. Not so; it simply increases a Dai holder’s exposure to the price of the underlying Ether. If Ether gets wiped out, the Dai collateral will be worthless, so the user will have lost $150 in an effort to create $100.

Maybe Byrne is right. Maybe stablecoins in their present form are a waste of time. But I doubt it will stop us trying to create frictionless digital payment systems.

We might not all be using a modified version of bitcoin by next year. But it would be hard to imagine we don’t see some sort of financial innovation to our transactional system.

Cryptos have got the ball rolling. And I can’t wait to see what happens next!

Your friend,

Harje Ronngard


Harje Ronngard is one of the editors at Money Morning New Zealand. With an academic background in finance and investments, Harje knows how difficult investing is. He has worked with a range of assets classes, from futures to equities. But he’s found his niche in equity valuation. There are two questions Harje likes to ask of any investment. What is it worth? And how much does it cost? These two questions alone open up a world of investment opportunities which Harje shares with Money Morning New Zealand readers.


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