A potential solution to an old problem from an unlikely player in the Token Economy.

Credit: fxopen.com

CASH NOW!

Newcomers to the blockchain space often ask this simple question: How and how quickly can digital assets like Ether and Bitcoin can be converted back into their native fiat currencies?

The answer is with a simple click that initiates a bank transfer after executing a sale through many of the more reputable world exchanges (including Coinbase, Gemini, BitStamp and more).

On many smaller trading platforms though, banking complications create legal difficulties for businesses and fears of insolvency add risk for users. Many exchanges instead choose to exclusively trade tokens to avoid the legal constructs required of a financial exchange trading fiat currencies.

Still, facing demand for a steady trading pair during times of high market volatility and the ability to move fiat funds off of exchanges without trusting said platforms (i.e. if the business’ cash-reserves were called into question), the need for a “stable coin” has for years been widely recognized.

“Stable coin”: A digital asset with a non-fluctuating value, or a ratio of 1:1 with a fiat currency.

ENTER TETHER

To date, Tether is the closest that the blockchain space has come to a recognized stable coin. According to their website, “every tether is always backed 1-to-1, by traditional currency held in our reserves. So 1 USD₮ is always equivalent to 1 USD”. Tether is owned a private company, and a “sister organization” to Bitfinex (a large digital asset exchange).

Tether is today used by large exchanges including Bitfinex, Poloniex, Bittrex, Liqui, and Kraken among others.

On its face the system works:

Businesses track fiat funds in the form of tether with the same distributed ledger technology used to view digital asset reserves, and users understand this representation of their fiat funds to mean more (being chain-based) than a generated number on a screen. Furthermore, if users’ bank accounts are connected to one of these exchanges, then a bank transfer is still a click away, as the business in turn will sell Tether for the usual $1.00 price before settling their books.

But what enforces this Tether system? Not much. The daunting issues around Tether have been well documented in industry publications (Examples below):

Coindesk: The Strange Story of Tether, the Digital Money That Claims it Isn’t Money

Coindesk: Tether Really Isn’t a Scam, Company Promises

Hackernoon: The Curious Tale Of Tethers

HOUSE OF CARDS

The event of an exchange hack can have a monumental impact on this industry (Read: Mt.Gox’s Lasting Regulatory Legacy). For newer readers, blockchains aren’t simply hacked and altered. The heists that you’ve heard of take place when centralized exchanges (private businesses through which tokens like Bitcoin or Ether are traded) are trusted with customer funds, but don’t correctly secure their assets resulting in stolen information and tokens. The rarity of such an event though alone provides some peace of mind for traders, and users are only at risk if their funds are on a targeted exchange, but what if many token holders were taken for a ride at the same time regardless of exchange and how could this happen?

The odds of multiple exchanges facing this fate at once are infinitesimal, but the collapse of Tether would lead to a crisis like none seen in the blockchain-era. While some platforms might maintain a matching cash reserve to make users whole, others which hadn’t sold Tether to balance books, and all offline Tether token-holders (in personal wallets) could be left without recourse despite Tether’s “always backed 1-to-1” guarantee.

Here are a few quotes pulled from the Tether.to legal page by Hackernoon better explaining the risks of simply holding Tether:

1. “There is no contractual right or other right or legal claim against us to redeem or exchange your Tethers for money.”

2. We do not guarantee any right of redemption or exchange of Tethers by us for money.

3. They are also not stored value or currency.

4. Tethers are not money and are not monetary instruments.

When the amount of Tether in circulation increases rapidly while sister-company Bitfinex both loses access to US banks and simultaneously recovers from a $90,000,000 hack, it isn’t difficult to consider that a party could have created additional Tether to sell for money (like the fed printing new notes). A less conspiratorial is a reminder that the blockchain economy is not altruistic and that a privately-owned stable coin without a profit making mechanism creates the potential for ulterior motives. Regardless, alternative ideas for stable coins should be explored both in case of Tether troubles, and in the spirit of diversification of risk.

NEW CHALLENGER APPROACHING

Which party then could guarantee the value of a token tied to a fiat currency? The issuer of that fiat currency is one contender.

Why though would a government be so inclined to create such a thing?

To track and to tax of course! Not interested? Don’t sell then, but there is a proposed trade herein that many law-abiding taxpayers might take, and one that Japanese banking institutions are rumored to be considering.

The solution would look a bit like this: A government, possibly in coordination with banking industry powerhouses, would issue an equal number of tokens to fiat currency held in reserve for the purpose of representing said tokens. Unlike Tether, they would be directly redeemable for the connected fiat currency. It could even come in ERC-20 form (Ethereum’s token standard) for better compatibility with coming decentralized exchange platforms.

IN IT FOR THEM

What’s in it for them? The Government Token (GT) would likely emerge as a legal fiat trading pair on registered Digital Asset exchanges. For governments, GTs could partially remove reliance on the trifecta of banks, exchanges and users for reporting capital gains.

Here’s how it’s done: Verified exchanges identify users through required KYC (Know Your Customer) standards and keep track of user-specific exchange wallet addresses (referred to as user-segregated wallets). Governments would then better understand the figure in taxes likely owed to them using DLT, which has recently been highlighted as a priority for tax agencies said to be under-collecting from token traders.

IN IT FOR YOU

A government issuer of a fiat stable coin would represent a natural solution to the problems listed above. It would somewhat protect against exchange insolvency concerns, and allow for instant transfer of fiat funds to and from exchanges without wire-fees or ACH wait times. The possibility could even exist in time to shift the burden of self-calculating taxable events on digital assets from users to businesses or governments.

Furthermore, the many privacy-focused users in this space would be unaffected so long as they steer clear of the GT, just as they would likely already avoid moving funds between the current banking system and AML/KYC required exchanges (often relying instead on smaller decentralized or foreign exchanges, or of course by holding and spending their funds in token form).

OVERREACH

Once this glass door is broken, is there any looking back?

A distributed public ledger records all of history, and once government chain-auditing begins it won’t likely stop. From which addresses, for example, did John Doe fund his KYC-verified Coinbase/GDAX account in years’ past and to what do his remaining assets amount? Were there any earnings originating from those same addresses that went previously unreported?

These and other deep dives by governments into public ledgers may well be enabled by the combination of GTs and the chain’s permanent record.

THE EYE OF THE BEHODLER

Many users of nationless and unowned distributed ledgers will always protect their right to privacy, but just as classic stock and bond markets would never allow anonymous payments or payouts, governing bodies will seek get their take from users who are cashing out as this space matures, even if they need to provide a service in the form of a stable coin to achieve that goal.

For some, this proposed trade of privacy for ease will be a coming-of-age for an industry, while for others it may well present the greatest threat yet to what began as an anarchic or libertarian cause.

Touching a Government Token would opt into that matrix, but users would remain free for as long as they so-choose. And thus the beauty of it all would be in the eye of the behodler.

BUT HOW?

What would all of this look like in practice? In The Government Token (Pt. 2, “The How”), we’ll take a deeper dive and look at how the creation of a fiat stable coin would work technologically, and we’ll explore the interactions between financial institutions and central banks that would be necessary to make this venture work for all parties.