Opportunity for Stablecoins to be Reserve Currencies
Based on the IMF’s goals, China’s efforts to usurp the reserve throne, and the E.U.’s efforts to establish an alternative to the US dominated SWIFT system, there are many reasons to believe that USD dominance may fade in the long term. There is little predictability in regard to how fast this will happen, or which nation’s currency (if any) will gain dominance. As a result, investors may seek to hedge against this shifting power dynamic by placing funds in an asset outside of the system altogether. This creates an opportunity for stablecoin companies who are developing assets that exist outside of these systems. There are a few types of stablecoin projects that can offer reduced exposure to these systems:
Diversification of Collateral: By being pegged to a basket of currencies, a stablecoin project could spread the risk of correlation to any one single currency. For example, because Tether is backed fully by USD, if the US suddenly experiences hyperinflation, the value of USDT would fall in tandem with USD. Compare this to Globcoin (GLX), which is backed by a basket of 15 currencies and gold. When USD experiences hyperinflation, the value of GLX only falls by a fraction because it is diversified.
Algorithmic Central Bank: A stablecoin whose stability is maintained through an algorithmic central bank is not reliant on existing monetary systems for its value. As a result, its purchasing power would not decrease—even in the case of an international government meltdown. Currently, however, projects in this category, such as MakerDAO, are pegging the value of their token to a fiat currency. This is being done in order to kick-start the token’s use as a unit of account (see section 1.3).
Non-traditional Collateralization: Stablecoin projects which are backed by assets with inherent value are somewhat protected from the above systems. For example, intellectual property (IP) is valuable in itself;as the value of a fiat currency fluctuates, the price of IP would rise and fall to reflect a constant underlying value.
Crypto-Collateralization: Stablecoin projects collateralized by other crypto-assets may exist outside of the current monetary system in that their underlying token exists outside of the current monetary system. For example, Maker DAO issues DAI stablecoins when users deposit Ethereum. Currently, DAI are pegged to USD, but eventually, voters on the system may choose to peg DAI to a basket of goods, or to drop the peg entirely.
Factors driving growth and success for stablecoins.
It is important to note that the opportunity to use stablecoins as a hedge against global reserve currencies is primarily targeted for the long term. It is unlikely that the dynamics of international trade will shift a great deal in the near term. Nor is it likely that governments and banks will feel comfortable holding crypto assets in their reserves to manage risk until private and institutional investors begin to do so. That said, we can estimate the factors which will be influential in a stablecoin’s success given a changing central bank reserve environment.
Non-correlation: Some ways to ensure non-correlation to existing monetary systems are diversification, use of an algorithmic central bank, use of non-traditional collateralization, and use of crypto-asset collateralization. Currently, stablecoins are pegged to established units of account. If this does not change, any investor who holds these tokens is still exposed to the risks associated with the currency it is pegged to. Therefore, the stablecoin companies which are best positioned to take advantage of this opportunity are companies that have viable plans to become their own unit of account.
Black Swan Resistant: Stablecoins which do not utilize at least a 1:1 reserve mechanisms are at risk of black swan events (see Models of Stablecoins section above). Algorithmic central bank and decentralized models must be proven over long periods of time before people will believe they are secure from hacking, algorithm errors, or underlying asset volatility.
Projects such as MakerDAO anticipate that they will be able to drop their peg to USD. For this to happen, they must be trusted as a meaningful unit of account by their user base. In the medium term, it is likely that projects will emerge that are well-positioned to be their own unit of account—making it fully uncorrelated. This asset would have huge market potential given investors’ need to diversify.
Conclusion
The current state of stablecoins is one of opportunity for founders and investors alike. However, a great deal of thought must be put into the driving factors of adoption for a given stablecoin. Stablecoin companies cannot simply expect that their token will receive mass adoption without careful targeting of specific user bases. By looking at various use cases of stablecoins, we can identify multiple opportunities that companies can capitalize on. These opportunities vary in time frame as wells as factors that drive success.
Use Case | Factors | Adoption Timeframe |
Dollarization | Number of useful businesses accepting currency, consumer trust, government regulation | Medium-Long term (5-10 years) |
Smart Contracts | Compatibility with Smart Contracts, consumer Trust | Short-Medium (1-5 years) |
Exchange Safe Haven | Liquidity, number of exchanges listed on | Short term (<1 year) |
P2P/P2B payments | Number of users, number of digital wallets, number of useful businesses accepting currency | (Medium term 1-5 years) |
Reserve Currency | Uncorrelated with Fiat, black swan resistance | Long term (10+ years) |
Stablecoin companies that understand their target audience will be able to create and enable new services. As Andy Milenius, CTO of MakerDAO, postulates, these services will act in the same magnitude as mp3 encoding. By integrating with many blockchains, stablecoin startups will gain exposure to the value creation on multiple smart contract platforms. Moreover, by being listed on well-designed digital wallets, stablecoin companies will position themselves as an on-ramping service to the world of cryptocurrency, and more and more people will turn to digitized value exchange. By maximizing the number of exchanges they are listed on and by ensuring price stability, stablecoin companies can increase use as a safe haven for crypto traders and general consumers. By maximizing the number of businesses that accept the token and by pursuing user trust, companies can increase their chances of adoption in developing countries. By maximizing liquidity and by minimizing correlation to sovereign currencies, stablecoin companies can also offer value as a fiat hedge. Given the momentum and added benefits of digital money on the blockchain, stablecoin adoption is almost inevitable. With successful stablecoin projects, we will see a more secure and borderless world. In the future, the infrastructure for instantaneous settlement similar in function to FedWire, a service that banks use to interact with the Federal Reserve, will be distributed to all businesses across the world. We will inhabit a future where mainframe-based Automated Clearing House (ACH) settlement systems are retired, and, because of this, transaction costs will be lowered for small businesses and dollarization will be expanded. Central banks will wire funds directly to individual wallets and thereby cutting out expensive intermediaries.