Stablecoin & Returns: A Take On Centralizing Decentralization

I’m fascinated by cryptocurrencies. It’s something I don’t yet fully understand, particularly as to the impact it will have on the economy at large, and yet, it’s something that’s captured my imagination. I’m enthralled by the comprehensive nature of the asset, how it can act as a vote in one instance, and as a form of money in another. Talking about cryptocurrencies is like talking about the wave-particle duality of photons — it’s something everyone know to be true, and yet most can’t grasp its precise meaning, nor the consequences of the finding.

Moreover, the underlying technology powering cryptocurrencies (the blockchain) is looking to turn the world on its head. It’s looking to decentralize, and redistribute power in established systems from the platform to the end users. It’s looking to topple the man in the suit. Except, recently, things have been going rather awry. New concepts and applications of cryptocurrencies are popping up all over the place to fix problems that cryptocurrencies caused.

Problem 1: Cryptocurrencies are too volatile.

We all know about this problem. This was the very issue that brought cryptocurrencies into the limelight in the first place. Take a look at the following anecdote:

A boy asked his bitcoin-investing dad for 1 bitcoin for his birthday.

Dad: What? $15,554??? $14,354 is a lot of money! What do you need $16,782 for anyway?

That. That’s how volatile cryptocurrencies were at its peak last year. Of course, that’s not to say it’s any less volatile today. But the point is, this price volatility was the main reason for Bitcoin millionaires, and the Bitcoin homeless. Many claimed it was more a casino than a financial asset. Which is why traditional financial players were shy in exploring the field.

This issue made it difficult for analysts to come up with price targets and recommendations for Bitcoin and Ethereum, let alone other cryptocurrencies. What’s more is that coins like Bitcoin, Ethereum, and Litecoin act as de facto liquid assets in the crypto space, in lieu of fiat currencies. The volatility of these liquid assets, compounded with the volatility of tokens, makes it incredibly difficult for investors to operate in the space.

The stability of the US dollar is a major reason for the success of the US financial system. Likewise, the Pound/Sterling is the main reason for the UK’s continued status as a global financial hub. If cryptocurrencies want to take hold as a viable financial alternative, stability is key. And that’s what many new projects are looking to fix.

Stablecoin

This is their solution — a cryptocurrency that will keep a stable value, lending stability to the system at large. There’s three approaches being attempted at the time of this writing:

  1. Fiat collateralized stablecoins — These coins peg their valuation to a fiat currency of choice. In doing so, they’re guaranteeing that the central authority will exchange at the pegged valuation when requested, thereby providing a fiat currency alternative to the market. This does require them to hold a fiat currency reserve.
  2. Crypto collateralized stablecoins — These coins promise the much the same as their fiat collateralized counterparts, except their collateral is crypto. This requires the central authority to hold a crypto reserve.
  3. Non-collateralized stablecoins — These coins forgo the collateral approach altogether, opting, instead, for an economic solution, where the price stability of the coin is maintained through supply constraints in the open market.

The common theme here is a central authority — there’s a central power that either guarantees or controls the process in someway.

These powers, in essence act as central banks for their cryptocurrencies. Their approaches are different, but their result is the same — a centralized power. Whether that be a new institution looking to replace an existing one, or leaning on an already existing institution, crypto’s looking to create a record for stability in an effort to build cache for itself in the world.

Problem 2: Cryptocurrencies fail to perform as a currency.

The main argument of this is that you cannot lend cryptocurrencies today like you do real money. There are no systems in place, and anyone looking to do it must do so on an individual basis. This is something that a new startup is looking to tackle, and it’s something that I discussed in my previous Tidbits entry.

The premise is that this new startup will algorithmically set interest rates for crypto lending agreements, and allow individuals to freely lend on its platform.

As you can see, this is another instance of centralizing cryptocurrencies. The platform is looking to act as a central bank, setting short term interest rates, much like LIBOR rates in the real world. This allows people to forgo interest rate negotiations (which is the equivalent of price negotiations for any conventional good), and go straight to lending freely.

This is, very much, a recent development, so it remains to be seen whether this takes off, but it’s yet another instance where centralization is introduced to solve a problem that crypto caused.

Shortfalls of Decentralization?

The argument for decentralization was security. It was meant to get rid of the single point of attack, the single point of authority, and the single point of power. It was meant to put all that into the hands of the individuals. It was meant to speed up the process and create trust in the system as a result.

We’re now realizing the shortfalls of such a system, particularly as it compares to fiat currencies in real life. We’re realizing that these aren’t currencies — yet.

A huge part of what makes modern currencies “currencies” is the fact that they multiply like bunnies set free in the Australian Outback. They reproduce quite like nothing else out there, hence the concept of “return on investment”. Nothing like that quite exists in the world of crypto yet, save for the ICO for a new crypto startup that  raises funding in ETH or BTC. But you can’t open up a BTC savings account where the balance accrues interest. You can’t build a retirement on it; you can’t really do anything you would with traditional cash.

Moreover, because these currencies are bound to the blockchain, the supply is hardwired — much like the gold standard we had far before I was even born. Now, while proponents of the gold standard, and a return to “real capital” do exist, they fail to acknowledge the fact that a huge part of the acceleration of economic progress was due to the fractional reserve banking system that’s so prevalent today. You can’t do that with BTC or ETH.

But there are people who want to change that. There are people who think crypto can behave like fiat currency and get you returns on investments. By extension, you can bet there’ll people to create crypto banks that will try creating blockchains that allow for fractional reserve finance.

Will it work?

Whether these will work is still up for debate. As with any tech, there’s still a lot of uncertainty surrounding blockchain and cryptocurrencies, particularly in the delicate balancing act between blocksize and transaction speed, decentralization and process speed, security and speed.

Functionality and speed.

There’s no doubt that this is a revolutionary technology that has immense potential to change the world. But the world doesn’t wait for things that aren’t worth pursuing. We’ve seen that with Palm and its WebOS (now an LG IP), and the with smartwatches, which now rightfully sits as a niche devices. Tablets, too.

The point is, there’s no guarantee that this is the way of the future.

But, fortunately for the tech, there are analogue parallels we can draw from to reform and refine it to make it more palatable for the masses. And there are people, who are passionate enough about the tech, working day and night to make the changes happen.

With “3rd gen” blockchains like EOS and other projects surfacing left, right, and center, there’s real chance we’ll see the tech settle into its role in society, perhaps with some added benefits.

Who knows, maybe we’ll see a true-to-life version of Ready Player One.

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