Stablecoins Are Not Truly Stable…What’s The Solution?

Education, Innovation, Investing, Regulation | February 19, 2019 By:

The lack of economic stability threatens national security, health, and world order. From the debt crisis in Greece, inflation in Venezuela, and the rise and fall of Turkey’s economy, all demonstrate the dire consequences of failure to maintain stability. Even the United States, a global economic authority, has suffered a rollercoaster of recessions, crises, and depressions throughout its history. The current 27 trillion-dollar US debt has been an ongoing cause for international concern, and, since the current government took office there has been much speculation regarding how monetary policy could lead to a sudden plunge in the dollar’s value. Add this to the fact that all fiat currencies are constantly losing value, and you have a perfect storm of doubt, fear, and anxiety about the future value of your hard-earned savings and investments.

Where does value come from?

It all started with the need for a standardized measure of value, a need that only intensified as global trade networks grew. Imagine a farmer attempting to estimate how many chickens to trade for a new wagon. His chickens were not easily divisible or valued—standardized gold coins were much more practical. Carrying around pounds of gold was also a hassle, so governments began issuing paper bills with value directly tied to that of gold, a system known as the gold standard.

The problem with the gold standard was that governments couldn’t easily increase the amount of money in circulation to boost a stagnant economy, because increasing the amount of gold in reserve was not always feasible. This issue led Great Britain and the United States to effectively abandon the gold standard in 1931 and 1933, respectively (the US completed this process officially in 1971). By decoupling currency from gold, governments instituted a new monetary system, referred to as fiat currency, wherein the currency’s value is not linked to any particular asset. Instead, it is based upon shared belief and trust in the government issuing it.

It’s all about trust

As governments add more currency to circulation, the currency loses value and causes inflation. This leaves governments, companies, investors, and individuals with no truly stable and predictable store of value, or measurable financial index against which all other currencies can be compared to. At present, the US dollar is one of the most stable fiat currencies in the world, with an annual inflation rate that tends to stay between one and three percent, and so is commonly used as a financial index. But, history demonstrates the dollar is far from a predictable measure or stable store of value. The United States has experienced an economic crises once every ten years on average, including the Great Depression, the 1970s Stagflation, the 1981 Recession, the 1989 Savings and Loan Crisis, and the 2001 Recession. The most recent, the 2008 Financial Crisis, was instigated by lenders allowing too many people to take out subprime mortgages, which led banks to declare bankruptcy. In order to avoid an economic meltdown, the US government bailed out the banks, which saved the economy in the short term but led to an erosion of public trust in centralized government and financial institutions.

The rise of cryptocurrency

In response to the 2008 Financial Crisis, Satoshi Nakamoto released the bitcoin whitepaper, which outlined a novel system for peer-to-peer electronic payments. The most exciting thing about bitcoin for many was that it eliminated the need for centralized institutions entirely. For the first time in human history, people could electronically exchange value without going through a bank and without trust in a government. Since the inception of bitcoin, thousands of other cryptocurrencies have been created but none has broken through to the mainstream. Bitcoin was valued at around $1,000 in January of 2017, hit $20,000 in December, and now hovers around $3,500. This sort of dramatic fluctuation does not make for a safe store of value for investors, companies, or any organization. Indeed, many crypto raises that occured in 2017 and 2018 have lost much of the value raised due to massive market changes. Such oscillations are not acceptable for anyone wishing to secure their investments.

The desire for a more stable cryptocurrency to safeguard the new blockchain economy from constant see-sawing, led to the invention of stablecoins, which, in some ways, represent a return to more traditional monetary systems in that they are asset-backed. The trouble with many of the stablecoins on the market is that they are backed by fiat currency or cryptocurrency, and we know from our history that fiat currencies are constantly depreciating in value and cryptocurrencies remain incredibly volatile.

So, what is the solution?

Because no fiat currency, cryptocurrency, or stablecoin has yet offered a solution in the form of a trusted financial standard and measure of value, this need remains unfulfilled. Given increasing global political instability and eroding public trust in governments and centralized financial institutions, the stakes are high for finding one. As the history of value tells us, any workable solution will need to take a variety of economic and financial factors into account. The gold standard worked because it was asset-backed, but it didn’t allow for enough flexibility when the economy stagnated and inflation was necessary. Fiat currency endowed governments with more control over currency circulation, but, as demonstrated by the 2008 Financial Crisis, governments and financial institutions don’t always make decisions in the best interest of the general public. Cryptocurrencies rejected government backing and eliminated financial intermediaries, but cryptocurrencies have been so volatile that they cannot be trusted as a stable store of value or financial index. Stablecoins recognized a need for stability and predictability but failed to achieve it.

The system that successfully achieves stability, predictability, and trustworthiness will need to take what works from these systems and dismiss what doesn’t (in full disclosure, my company, Anchor, is developing such a solution). Imagine a future where a family in Venezuela can trust their savings will not become valueless the next day, where a company can rest assured that its investment raised will be safeguarded, and where governments around the world can protect their markets from debilitating fluctuations. Such a future is possible with a system that effectively builds trust, stability, and predictability into its very structure and safeguards you from the inevitable global economic storms.