Stablecoins vs. Govtcoins: The Race to Solve Cryptocurrencies’ Price Volatility Problems
After its inception on a quiet cryptography mailing list nearly a decade ago, cryptocurrency finally had its moment in 2017. As hype cycles go, it has been one of the hypest. And the most cyclical: As far as prices go, 2018 has been a bit of a hangover. Nonetheless, blockchain technology has crossed the chasm—if not in consumer use, then certainly in the general imagination.
Still, you can’t get too far away from those volatile prices. This is especially important for consumer use—it’s one thing to capture the imagination, quite another to capture the Average Jane’s daily morning-coffee transaction. And that doesn’t happen until Average Jane knows she’ll be quoted the same crypto price for her coffee everyday. For crypto, price stability is one of the keys to mass adoption, as I’ve shared in a past post.
Paths to Cryptocurrency Price Stability
There are a few different paths to crypto price stability: 1) blue-chip cryptocurrencies like Bitcoin stabilize as time wears on and their novelty wears off; 2) tokenized fiat currencies that share their paper counterparts’ stability launch; and 3) cryptocurrencies specifically designed with stability in mind take off.
There are good reasons why the blue-chip cryptocurrencies are so much more volatile than their fiat friends. Fiat is a centralized currency—it is controlled by a government and central bank, which can print more or less of the currency, or raise interest rates on in-country bank deposits to make holding that currency’s cash less desirable. In other words, it can manipulate supply and demand of the currency to stabilize its value.
Cryptocurrencies can’t do this because they’re decentralized—there’s no one manning Bitcoin’s rudder who can quickly take actions to stabilize its price (except for maybe Satoshi or those twins from the Social Network). However, this doesn’t mean that cryptocurrencies with stabilization processes in place can’t be designed. They can be, and they’re called stablecoins.
Types of Stablecoins
Courtesy of an excellent analysis by Haseeb Qureshi (Multicoin Capital’s Myles Snider offers a similar framework), we can sort stablecoins into three categories: fiat-collateralized, crypto-collateralized, and non-collateralized.
- Fiat-collateralized stablecoins - These are pegged, generally 1:1, to a fiat currency—they maintain value because every unit of stablecoin is “backed” by a unit of fiat. So, hypothetically, you can always exchange 1 stablecoin for 1 fiat, and so their values converge. The most popular (though I use this term loosely) fiat-collateralized stablecoin is Tether.
- Crypto-collateralized stablecoins - These use smart contracts to “lock up” other cryptocurrencies in a smart contract, which then backs the stablecoin. While the stablecoin in this case has to be overcollateralized to compensate for other cryptocurrencies’ volatility, in theory you can always liquidate your stablecoin for other cryptocurrency. MakerDAO is the most prominent of these stablecoins.
- Non-collateralized stablecoins - These algorithmically manipulate supply and demand to maintain the price. In essence, it acts as an automated central bank, a rudder that manns itself. Basis is the early leader in this pack.
The nature of each stablecoin is critical to any discussion about which is likely to come out on top. And there aren’t likely to be many, as currencies carry some of the strongest network effects out there (a currency with no willing counterparties is about as useful as a one-man handshake). It’ll be an engrossing contest. But the fate of stablecoins is ultimately going to come down to the actions of governments. Tokenized fiat—a state-backed cryptocurrency—is the Big Boss at the end of the video game.
Stablecoins vs. Govtcoins
The most pressing reason for a government to launch a cryptocurrency is the success of private cryptocurrencies. This isn’t out of some misplaced sense of competition, but rather because governments would be loathe to lose control of their nation’s monetary policy. When asked about the potential governmental response to cryptocurrencies, former IMF Chief Economist Kenneth Rogoff’s response was, “When it comes to the monetary system, the government makes the rules. You cannot win the game. If they're not winning, they will change the rules.” If this doesn’t mean stringent regulations—and governments so far have been much more concerned about the scammy or bubbly elements of the crypto world than its capacity for toppling fiat—it could mean govtcoins.
Stablecoins carry several advantages over govtcoins. For one, since stablecoins are not “issued” by nation states, users do not have to worry about government surveillance. In countries helmed by oppressive governments, decentralized stablecoins could still be popular for this reason. Additionally, it’s reasonable to project that if governments can program their currencies, taxes will be built into the govtcoin. If people or entities wish to avoid taxes, they could choose to stash their capital in decentralized stablecoins over currency havens or other govtcoins (though this is obviously not recommended - ‘always pay your doctor and the IRS’). Finally, stablecoins also offer potentially easier access as governments might attempt to restrict ownership of their cryptocurrencies to own-country citizens.
The Fallout of Stablecoins in a Govtcoin World
Let’s say that governments broadly adopt national cryptocurrencies, leading some smaller countries to adopt larger-country currencies and a few currency-haven cryptos become popular (e.g., CaymansCoin) among tax-evaders and libertarians. What does this mean for stablecoins?
Different types of stablecoins will react differently. Fiat-collateralized stablecoins like Tether and TrueUSD are the most likely to suffer in the aftermath of mass govtcoin issuance. These stablecoins function as a USD crypto substitute—their value doesn’t merely track the dollar, but is backed by dollars. If the U.S. were to launch an actual cryptodollar, however, there’d be no reason to hold Tether or TrueUSD, since you could simply purchase cryptodollars instead of those less approximate substitutes.
It’s less clear how crypto-collateralized (e.g., MakerDAO, Havven) and uncollateralized/algorithmic stablecoins (e.g., Basecoin/Basis, Carbon) would fare in a world of broad govtcoin issuance. These types of stablecoins, unlike the fiat-collateralized kind, needn’t track the dollar or a fiat currency in value. The Basis and Carbon whitepapers each noted that while they would initially follow the dollar, they could switch to tracking a basket of goods, much as the Federal Reserve uses personal consumption expenditures to determine inflation rates. So it’s possible for these stablecoins to act as more than a ghostly version of USD that inhabits the netherworld of cryptocurrencies.
Ultimately, cryptocurrencies cannot become a true medium of exchange without solving their price volatility problems. While Bitcoin and other leading digital currencies may eventually stabilize, waiting around for this uncertain future will delay crypto’s mainstream ascension. Stablecoins provide the central bank-like infrastructure to solve the stability issue, but it remains to be seen what would happen to their use should a country decide to roll out its own govtcoin. While governments around the world carefully consider their options for cryptocurrencies (and the many hurdles involved), however, stablecoins are benefitting from a sizable head start. I wouldn’t really consider Venezuela’s state sponsored petro cryptocurrency as any kind of indication, but more reputable central banks will likely emerge with blockchain experiments in the next few years. Government has rarely been a place for innovation so I think any meaningful rollouts are the better part of a decade away.
Sunny Dhillon is a founding partner at Signia Ventures, a $100m seed and series A venture capital firm based in the San Francisco Bay Area. He invests in consumer and enterprise startups. He previously worked as the first business development employee at a venture backed spin-off of New Line Cinema, directly for the Lord of the Rings trilogy producers (hat tip to Mark Ordesky), as well as in corporate strategy for Warner Bros., before launching his own startup and becoming an investor.
Special thanks to Signia's Alex Lloyd George for his help on this article.