by Fred Pye (CEO, 3IQ) and Kesem Frank

Stablecoins: tactical origins, strategic implications

Calling the cryptocurrency market volatile is an understatement, the past couple of years have been defined by incredible bull runs as well as steep corrections, with same day prices that can fluctuate by over 10% for even the biggest and most established crypto assets. Stablecoins have emerged as an effective tool to hedge this massive volatility, with a simple premise that allowed traders a seamless crypto pair into a fiat pegged cryptocurrency (for the purposes of this article we are not addressing the different and more exotic kinds of stablecoins). It might sound overly simplistic, but this straightforward innovation has spurred the growth of a new crypto asset class that measures in billions of dollars in aggregate market cap¹:

As much as this asset class is still gaining momentum driven by the current and common use case, we believe that the potential of stablecoins go well beyond the tactical value of a trading tool. Simply put, stablecoins are strategically important because they represent a bridge between our legacy fiat-based systems and the new digital and decentralized currency underpinnings, we collectively call “blockchain”. In this article we’ll argue the point of stablecoins as a necessary step on the path to mass adoption of cryptocurrencies.

The path to wide adoption; a mainstream iteration to the purist vision

Blockchain’s earliest and (still) largest network, Bitcoin, came about in the midst of extremely tumultuous years for our traditional financial system. Those years were especially defined by common mistrust; not just towards the people at the helm of the financial system, but more profoundly, mistrust of the system itself. It is not surprising then, that Bitcoin’s innovators and early adopters were driven by a vision of an extraneous system that completely rejected legacy framework. Our very first cryptocurrency is characterized by concepts such as headless decentralization, immutability and deflationary currency to name a few. Early blockchain advocates will argue that this is the only acceptable implementation for this technology, with any deviation from the original guiding principles being a compromise (and probably much worse). However, it is the same purist vision of “utility backed value” that makes bitcoin (and other cryptocurrencies that follow similar design guidelines) incredibly susceptible to speculation and volatility.

Regardless of where you stand on the matter of adhering to the original guidelines, it is important to clarify that this article is by no means meant to criticize the original blockchain (the authors are actually very long bitcoin). The question on our mind is not around bitcoin’s value, rather on its applicability. We deal with the issue of how to make this important technology widely utilized, so in simple terms, the question is actually, “Is bitcoin’s design right for mainstream adoption”?

Another important clarification is that this article isn’t written in light of the major price declines of the past 15 months; even the incredibly bullish market of 2017 posed significant challenges for the utility of bitcoin as a mainstream tool. In Joel Hruska’s great article written a couple of months before bitcoin’s ATH, he frames the problem of too bullish a market quite elegantly: “intense deflation causes severe problems in economies. If you know that a dollar today is worth $5 a year from now, you’re going to fight like hell to avoid spending a single dollar more than you absolutely have to. In fact, you may choose to temporarily go without things you’d otherwise purchase. One of the problems with a widely fluctuating price for goods and services that’s also in a deflationary spiral is that even fractional amounts of money at the time you spend them are later worth insane amounts of capital. The first Bitcoin transaction for a real-world set of goods and services was when Laszlo Hanyecz paid 10,000 BTC for two pizzas. That came to $41 at the time — and would now be $150M to $160M today. Anybody hungry enough for pizza in 2010 that they couldn’t have skipped it for that kind of return seven years later?”²

Recapping the above, when solving for mainstream crypto adoption, it is clear that both up/ down markets as well same day volatility pose significant challenges for mainstream usability. Summarizing the issue to a single word: on the path to mass adoption, a key factor to solve for is stability.

What’s the point of crypto if it’s not Satoshi compatible?

We’re now getting back to where we started, stablecoins themselves. Collateralizing and representing fiat currencies as digital tokens on a blockchain is a very straightforward approach to address price stability. A dollar is worth a dollar, even in its digital form. However, this is not as Satoshi intended, and is a major divergence of the original decentralized and deflationary design (read; bitcoin was trying to get rid of central banks, not to empower them), so a very good critique of stablecoins is questioning whether “just” tokenizing fiat currencies creates enough of a benefit or even if it is worthwhile doing at all.

The short answer is yes. Blockchain is an incredibly powerful architecture that provides significant benefits to the assets represented on it. This is still true even when those assets aren’t native crypto assets in the traditional sense. Without getting into the technical details of how today’s major networks work, we believe that there are many key benefits to blockchain based tokenized fiats, and have listed three below:

Speed, Span and Cost

A tokenized asset can be moved around the globe at an efficiency that current day systems cannot come close to competing with. A transaction between wallet holders on opposite sides of the globe would be settled in seconds (or minutes, depending on the specific network) for an average fee totalling fractions of a dollar. The digital assets being moved would incur the same fee regardless if they are worth a few dollars or a few million dollars, and would be available for use immediately after finality has been achieved on the underpinning blockchain (think minutes, not days or hours). For most of us used to dealing with traditional channels, or even worse, if you’ve ever had to wire money between accounts, this will be a significant and welcome improvement.

Transparent and Immutable

Although we dedicated a part of this article to the explanation of why bitcoin like “headless” design isn’t necessarily suitable for mainstream use cases at this point, the blockchain architecture is vastly beneficial even when the assets it underpins aren’t “crypto-native”. Specifically, the transparency and immutability inherent to the architecture enable incredibly powerful new methods of bookkeeping and reporting such as Triple Entry Accounting (TAE)³ as well as Automated Audits. These pose a substantial improvement to current accounting tools, that eventually will change the risk profile inherent to every financial transaction.

True ownership

We might be very excited about TEA, but in all honesty we don’t need to go too far to find immediate benefits of blockchain based assets. For most of us, even the concept of ownership itself is one step removed due the prevalence of intermediaries in current systems. Most likely, a trivial action of checking the current state of our assets involves logging-in or calling our bank and asking it to report back what and how much we own. The analog process in a blockchain based system is the equivalent of having a direct line of sight to the vault itself.

Welcome to the future, good luck!

Finally, let’s loop back to the point we started with: stablecoins positioned to “form the connecting link between our legacy systems and the blockchain future”. For anyone to enjoy the benefits described above (among a multitude of others we did not cover), a pretty significant leap was required: move away from a widely accepted and understood fiat based system and onto the hacker dominant world of crypto. For the majority of people, that leap is just too wide to even consider at this point, leaving us in the blockchain industry asking what we should do to improve the situation. For a very long time, the predominant response by the industry was “The future is already happening, it’s up to people to catch up”. For many in the industry who bought/ mined/ got their first bitcoin around 2013 (or earlier) this is still the prevailing point of view. But even the most adherent purist will admit that the power of this technology vastly increases with the growth of its userbase. In other words, it is in everyone’s best interest, early adopter and newcomer alike, for the network to grow by appealing to the mainstream.

Gladly, we (and many others) are solving for this exact point, by actively trying to facilitate better access to much wider audiences. We recognize that going “fully crypto” might be too much to chew on for most, and so we are busy working on creating a more palatable bite size. We have learned from some of the most profound processes of digital transformation of recent decades and are aiming to utilize the applicable lessons for this particular case.

Take the wave of smartphone adoption as a case study: within a single decade the absolute majority of the world’s population has been converted into avid users of this new technology. While there are multiple applicable takeaways and lessons to analyze, consider the name itself “Smart-Phone”. If you own one (and you most likely do), it probably isn’t necessary to point out that most of the time the “phone” aspect of the device isn’t used at all. In fact, recent data⁴ show that of the top 10 use cases for smartphones, calling people only ranked 11th. Still, there is a very important reason that these pocket computers were named “phones”. To spur their adoption, it was necessary to anchor the net-new technology with the familiar. It is much easier to have a meaningful conversation, when we have a common mental framework to base it on.

Conclusion and next steps

We believe that for crypto going mainstream, stablecoins represent an ideal common framework for most people to think through. Sure, they are based on new and different technology, but we can fundamentally establish a simple formula such as one coin equals one dollar. If we can have this common understanding, we can progress to having the more important conversation as to why the coin is actually a better dollar than a dollar, but we’ll be doing so standing on sound foundations.

We are working on an implementation that will inherit all the benefits covered above but will also comply with the applicable regulation/ legislation in place. In current markets dominated by USD based stablecoins, it is important to remember that we need to deliver efficiencies around foreign exchange for stablecoins to truly become strategic in importance. This will be possible through a Canadian Dollar backed crypto asset, that will unlock the next adoption stage of blockchain and will generate direct benefits for Canada.

Stablecoins will continue to play a major role in broader crypto adoption, and for our part; a CAD-backed crypto asset will be an important step in the evolution to mainstream adoption of blockchain. We are very excited to be engaged in architecting the future of financial systems; good things are coming.