Written by: Haseeb Qureshi, Managing Partner of Dragonfly Capital
Compiler: Perry Wang
US Congress by the end of this year, the newly proposed “Stabilization Act” (STABLE Act), brought a lot of controversy for the encryption industry, which would require a stable currency issuer must obtain a banking license.
If the bill is passed into law, it will force stablecoin reserves to be regulated like bank deposits. Given that stablecoins have now become the de facto currency of today’s crypto ecosystem , if the above situation becomes true, it will be a huge setback for stablecoins.
The crypto industry quickly responded fierce and angry. For a time, exchanges, wallet agencies and entrepreneurs strongly condemned this bill and its possible consequences.
The sword of Damocles has not yet fallen, because the “Stability Act” may not be passed into legislation in Congress. However, the US President’s Financial Markets Working Group just issued a stable currency-related regulatory statement stating that stable currency holders should accept KYC for user identity verification .
This statement has no legal effect, but it shows that the spirit of the times has changed.
In the past few years, stablecoins have achieved tremendous growth and are largely immune to regulatory interference. Is this situation sustainable? Does the Stability Act foreshadow what is about to happen? In the end what will change Tether’s stable currency USDT or decentralized stable currency?
I think the answer is simple: regulation is one-way development. Centralized stablecoins will gradually be subject to more and more restrictions, thereby pushing the crypto economy to decentralized stablecoins .
It won’t come true overnight. But I think this will happen eventually.
Let’s review the stablecoins first, and then present my views to readers one by one.
The origin of cryptocurrency
Initially, Satoshi Nakamoto invented Bitcoin and created a decentralized digital currency. In the early days, Bitcoin (BTC) was indeed a “decentralized digital currency.”
Before 2018 , BTC was a cryptocurrency denominated asset. If you want to buy goods with cryptocurrency, you can buy with BTC. No other cryptocurrency is global or liquid. BTC is the reserve currency for almost all crypto transactions. Even most ICO fundraising is done through BTC and ETH.
But BTC is not a perfect currency. It is known for its high volatility, coupled with a block generation interval of up to 10 minutes and a confirmation time of up to one hour, making it impossible to become an ideal trading medium.
Therefore, after the ICO bubble collapsed in 2018, we entered the second phase of cryptocurrency : the Tether USDT stable currency era. This is the stage we are currently going through.
USDT is a stable currency: a programmable digital dollar “without permission”. The most common stable currency is legal tender for a stable currency mortgage is basically the equivalent of IOUs IOU bank account held by the dollar. Technically speaking, each USDT is an IOU issued by Tether Limited, giving you the right to obtain their USD deposits held by Deltec Bank in the Bahamas.
I don’t want to call it a stable currency, and prefer to describe USDT as a crypto dollar. The ” crypto dollar ” clearly shows that this will fundamentally be a new currency phenomenon.
You can think of crypto-dollars as a new step in the monetary system—they are dollars as abstract monetary assets that are converted into non-political and permissionless ERC-20 tokens, effectively delinking from the U.S. banking system .
USDT is not the only crypto stable currency. But up to now, it has become the top stable currency in market share with an amazing growth rate.
Stablecoin provided by the issuer, source: Debank
However, USDT has a history of high-profile disputes and is currently under investigation by the US Department of Justice, the US Commodity Futures Trading Commission CFTC and the New York Attorney General’s Office.
Tether admitted in 2019 that USDT supply is not 100% backed by U.S. dollars, but its supply has only increased monotonically over time. In view of this, you may wonder why Tether’s USDT is more popular than USDC , which is regulated and supported by Circle and Coinbase.
The answer is simple: USDT is the most important stable currency in the world because it is the first stable currency to enter this market. It has existed for a long time, so that it has become the most liquid, most demanded, and most credible neutral stable currency in the world. (In Asia, Tether’s fuzzy regulatory status is a plus compared to the more stringent USDC.)
Most cryptocurrency exchanges have the most trading pairs quoted by USDT. The trading volume of USDT is higher than that of BTC itself. It can be said that USDT is now the deposit currency in the cryptocurrency field.
How long can the reign of USDT last?
USDT’s market share is growing rapidly. As it gains more and more attention, I expect that more and more people around the world will realize that cryptocurrency is a better way to access open dollar flows from anywhere in the world. Cryptocurrency is truly global digital cash. This makes them extremely attractive internationally, especially in countries with strict exchange rate controls .
For example, in China, according to the law, each citizen can only have a purchase quota of US$50,000 per year. Most BRIC countries face similar policies (not to mention countries facing severe inflation like Argentina, Iran or Lebanon).
Regardless of the country/region involved, most cross-border transactions are conducted in U.S. dollars. The US dollar is more or less the de facto currency for international business . This gives the U.S. government great privileges to execute its foreign policy not only by relying on its military power, but by relying on its control of the global financial infrastructure.
But countries are increasingly dissatisfied with the powerful financial hegemony of the United States. In today’s cross-border trade, especially in the border areas between China and Russia, the utilization rate of USDT is increasing. This allows companies to accept the economic stability and neutrality of the U.S. dollar while delinking from the US sanctions stick.
After the outbreak of the new crown pneumonia, the world’s emerging middle class may increasingly seek currency security and diversification . For many people, the permissionless cryptocurrency will become their entry ramp.
Growth of active Ethereum stablecoin payee addresses (mainly USDT), source: Joel John
The future of cryptocurrency is bright. However, can USDT survive long enough to see that bright future?
This is a serious problem at the core of the encryption industry.
Free deposit
USDT is essentially free deposit.
Recall that USDT is under investigation by a number of US agencies and prosecutors. So far, there is hardly any strong defense evidence. It has never conducted a comprehensive review of its reserves. Tether does verify customer identity KYC work on its entry and exit ramps, but this extremely weak compliance cover is unlikely to allow them to escape the US government’s supervision. Please note that Tether has blacklisted 250 addresses among its millions of token holders.
Everyone knows that this situation is unsustainable. The larger the USDT market, the larger the target .
Tether addresses that have been banned over time (less than 0.1% of the total addresses), source: Dune Analytics
Of course Tether knows this well. Now they are playing a cat and mouse game with their business relationships with banks, jumping from one bank to another (Wells Fargo, ING, Noble Bank, Deltec) until they find a bank that accepts their funds.
This will not last forever: Eventually Tether will be shut down or supervised and eliminated.
That’s right: the day Tether shuts down will have catastrophic consequences .
The crypto market will be censored, exchanges will fall into chaos, millions of crypto traders may be frozen, and prices will plummet everywhere. (This will declare death again for Bitcoin.)
But as always, cryptocurrencies will eventually come back to life. When the dust settles, we will enter the third phase of cryptocurrency .
The order book will be restructured around the new cryptocurrency. The international cryptocurrency market will soon recognize this new standard and is eager to resume business.
But what kind of crypto dollar will replace Tether’s USDT?
The rise of RUSD
Currently competing with Tether’s USDT are regulated stable currencies such as USDC, BUSD and TUSD (soon there will be Facebook’s crypto project Libra “also known as Diem” entering the market). We don’t need to care about which stablecoin will win this battle. We will call the winner ” RUSD” for the time being, which is the regulated U.S. dollar.
RUSD will have the same intuitive functions as USDT, but more compliant and trustworthy. Over time, RUSD will replace the role of USDT in the international market and meet the demand for permissionless, non-political dollars.
Will this be the final stage? The ultimate form of the dollar in the world?
I do not think so. In my opinion, the third stage, the RUSD era, will eventually end .
The curse of digital cash
At present, stablecoins backed by fiat currencies have been effectively regarded as cash . Anyone anywhere can pay anyone they want in any amount they want. Only when these tokens are exchanged for their base dollar will they reach a legal checkpoint. Prior to this, there was no meaningful legal supervision in the circulation of these tokens.
Imagine when these stablecoins will be sanctioned and prohibited from being treated as cash in the law. As JP Koning pointed out, aren’t all banks beginning to adopt them? Stablecoins will effectively enable you to bypass the US Bank Secrecy Act . In this version of the world, anyone can freely transfer 50 million US dollars to anyone else in the world immediately, without asking any questions, and unable to determine the identity of either party after the fact.
If this situation continues, stablecoins will become the most powerful bank hacker ever. Once bank deposits become the target of financial supervision, they will be seriously inferior to digital cash. If this is recognized by regulators, it will only be a matter of time before stablecoins swallow most of the global dollar settlement.
I am not saying that this is impossible! But I seriously doubt it.
Over the past 50 years, the development of supervision has been one-way: increasingly strict financial supervision, domestic and foreign policies combined with economic control of the global financial system. This trend accelerated after 9/11 and the 2008 financial tsunami.
Source: Mercatus Center
Of course, no matter whether the US government sends blessings, digital currencies without permission will eventually exist. But will the regulator recognize its inevitability and let the US government sanction its own digital dollar?
I suspect that they cannot resist the temptation to enter the ledger, which is to block the address of the enemy, reward its allies, and directly control the monetary system to pursue policy goals . If they do, then this version of the digital dollar will be indistinguishable from the current banking system.
At present, due to the high-profile pursuit of “innovation”, “RUSD” is retained. However, Rohan Gray , the designer of the Stability Act and assistant professor at Willamette University, briefed us on the views of regulators: Are these fiat-based stablecoins not just fully-reserved digital banks?
Should their debts be treated as cash forever rather than bank deposits? Can the U.S. regulatory machinery resist the urge to supervise this matter? The short history after the promulgation of the American Patriot Act tells us that it may not be.
Even the Financial Action Task Force (FATF), a global intergovernmental organization that sets global standards for anti-money laundering regulations, recently wrote that stablecoins “should never override the scope of anti-money laundering controls .” Similarly, the US Financial Stability Board (FSB) recently urged regulators to follow the principle of “same business-same risk-same rules, independent of underlying technology” when supervising stablecoins. The European Central Bank President recently agreed.
These RUSD are currently entering the regulatory radar as ” digital cash .” But make no mistake: regulators don’t want any such things to exist.
What is the anonymity and untraceability of cash? Cash reduces the readability of the economy , so it is the enemy of the state. If cash no longer exists, the government will never allow it to be reinvented.
The only thing that can save the face of RUSD today is that the scale of RUSD today is too small to attract real attention from regulators. Today they are mainly used for speculative trading of cryptocurrencies , which is a harmless pastime. In the US dollar environment, they are only a bright spot on the map (in general, the total issuance of all RUSD stablecoins is less than 20 billion US dollars, which is about 1% of the US dollar deposits of commercial banks).
Therefore, what factors will trigger the regulator to intervene and stop the cryptocurrency feast?
I can imagine two scenarios. One possibility is the surge in the issuance of RUSD to meet growing global demand. Worrying about the exponential growth of stablecoins may cause the U.S. Congress to make a big push to reverse the situation.
The second scenario may be triggered by the Black Swan incident: for example, headlines about someone using stablecoins to fund terrorists , or an authoritarian country using stablecoins to evade US sanctions. There will be calls for immediate supervision of cryptocurrencies.
Please note that I think RUSD will not completely withdraw from the stage of history. They are likely to allow small balances without KYC, but after a certain size, the account must go through KYC to receive more funds. Or, they can be regulated like banks and enforce KYC on all cryptocurrency holders. RUSD will have to start to strengthen the terms of use and actively monitor account fraud (not very strict at the moment).
Once this happens, RUSD will no longer be a satisfactory solution to meet the global demand for crypto dollars. They will be used for institutional purposes in the United States, but for non-U.S. individuals or those who are excluded from financial services, they are subject to too strict supervision and unreachable. RUSD will essentially become a bank deposit with enhanced functions.
Until then, and only then, we will enter the fourth stage of stablecoins : the stage where decentralized crypto-dollars have the upper hand.
The ultimate form of the crypto dollar
So far in this article, I haven’t mentioned any decentralized stablecoins . This is intentional: until the node mentioned above, decentralized stablecoins have a chance to be truly adopted.
Why do I say it takes so long? Why must all other channels fall into a situation where decentralized stablecoins have a chance to win?
The main feature of a stable currency is of course that its value is $1. However, the price anchoring of decentralized stablecoins is always relatively weak, so it is at a disadvantage compared with centralized stablecoins.
The relationship between USDT price anchoring (green line) and Dai price anchoring (red line) in 2020, source: Coinmetrics
The stable currency backed by legal currency maintains its price anchor by creating a cashing cycle , similar to an ETF. If the price is too high, arbitrageurs can invest US dollars to mint new stablecoins and sell the stablecoins on the open market for profit. If the price is too low, they can buy stablecoins and exchange them for U.S. dollars to make a profit. All of this is a fast and low-risk operation, enabling arbitrageurs and market makers to quickly ensure that stablecoins are anchored to the U.S. dollar.
ETF creation-demonstration of redemption arbitrage, source: Michael Kitces
Encrypted native stablecoins are different. Their price anchoring power is weak , because there is no real arbitrage in their price anchoring, and their operation is more like the central bank setting price range targets. Monetary policy is running slowly. When the currency is out of anchor, the central bank will try its best to react in real time. Speculators may bet that anchoring will resume soon, but this is not arbitrage; it is best described as ” short-term speculation on the future effectiveness of monetary policy.”
But this mechanism is very effective! It does create a decentralized stablecoin. The current Dai proves this. In 2018, when the price of ETH collateral fell by about 95% in one year, Dai still survived and maintained its peg to the US dollar. It even survived Black Thursday , when the ETH collateral was Prices plummeted by more than 50% in one day.
We know that the mechanism behind decentralized price anchoring can play a role in highly volatile markets. But we also know that they are not as prosperous as centralized stablecoins, which is not surprising given that their mechanisms are much more complicated.
Decentralized stablecoins cannot compete head-on with stablecoins anchored to the dollar price. But decentralized stablecoins have an advantage: decentralized stablecoins are indeed censorship-resistant .
Unfortunately, the market doesn’t care at all. Because currently, no one is conducting a large-scale stablecoin review.
If these centralized stablecoins have not actually encountered censorship, what USDT provides is the same as what Dai wants to provide you, except that it has stronger liquidity and tighter price anchoring. At present, in terms of practical purposes, Dai is a worse stable currency than USDT.
But this situation will eventually change.
The sharp edge of censorship will fall, because regulators will not tolerate truly unregulated digital cash. Once they implement supervision of legally supported stablecoins , stablecoins are only valuable if they are censorship-resistant, and then only assets such as Dai , Celo, or ESD can become suitable denominated assets in the crypto industry.
This is why I believe that the decentralized crypto dollar will become a long-term view of the future currency of the crypto world. I believe they will fundamentally change the global financial landscape .
But this will not happen soon. It is difficult to clarify the timetable here, but it may take more than 3 years to fully manifest. Given that there will be many other changes in the world by then, any forecast that seems so distant will inevitably become blurred.
The current “Stability Act” is a legislative proposal. It is not an end in itself, but a harbinger of a future end .
At the same time, as an investor, I am optimistic about decentralized encrypted stablecoins. In the long run, they are the only truly long-term effective way for people to decentralize their access to dollars from anywhere in the world.
Interests: Dragonfly has invested in MKR, CELO and ESD projects.
