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CommentByte Me

Byte Me: stablecoins buck and break

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Stablecoins are a curiosity unique to the cryptocurrency market and, despite the placid sounding name, have been embroiled in some of the hairiest controversies in the market. And they aren’t even stable.

Stablecoins are cryptocurrencies pegged at a ratio of 1:1 with fiat currencies. Obviously, one doesn’t buy into stablecoins for the returns (although if you were, for some reason, paid in bitcoin and buy everything with bitcoin, investing in a stablecoin pegged to dollars would have produced a pretty good return over the year).

Stablecoins provide an important market utility for cryptocurrency speculators. In a 24 hour market, it provides a convenient way to keep safe from overnight volatility, while you catch up on some sleep, much more quickly and easily than cashing out for fiat currency.

But they have largely proved too good to be true. Tether, the largest stablecoin by market cap, has been beset by suspicions that it was issued willy nilly, rather than in response to demand and uncollateralised by fiat currency, in order to inflate the value of bitcoin. Tether denies the allegations. The SEC subpoenaed the board of Tether in early 2018.

Tether has refused to publish an audit of its fiat holdings and has had little success in holding on to a banking relationship. After failing to find a US bank willing to serve its needs, it turned to one in Puerto Rico, which promptly went bust. Tether now banks with Deltec in The Bahamas.

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Are some cryptocurrencies a crumbling house of cards?

All this appears to have taken its toll on the coin’s credibility. It came to a head this week in the form of a minor run on tether and cryptocurrency exchange Bitfinex. The stablecoin dipped to $0.93 earlier in the week and was trading around $0.97 as of Thursday afternoon. Rather amusingly, some other publications noted this as a bitcoin price rise instead of a tether price fall.

But even the more credible stablecoins have failed to maintain their pegs. Last month, the brothers Winklevoss launched gemini dollar. As with tether, it was to be a fully collateralised coin backed by fiat deposits, (rather than the more complicated and even less reliable algorithmic stablecoins), but unlike tether, these deposits are to be subject to regular audits.

The gemini dollar peaked at $1.19 on Tuesday. It has since recovered, sinking back to $1.02 as of Wednesday afternoon. Paxos, another of the more trustworthy stablecoins, hit $1.10 this week.

Why would anyone pay more than a dollar for something that, best case scenario, is worth a dollar?

The answer is simple: liquidity (or the lack thereof). As investors rushed to get out of bitcoin, getting into paxos and gemini dollars proved easier, even at a premium, than getting buying fiat currency. Once an investor is in one of those stablecoins, they can cash out into fiat at their leisure, as long as they’re happy to swallow a 10% hit. Waiting around for someone to match a big bitcoin sell order on an exchange with thin liquidity might cost you a lot more than that.

Baby steps?

From the early days of blockchain adoption, the critique has always been that it can’t be scaled to keep up with real financial markets. A DTCC study published this week indicates that may not be true forever.

The study was carried out by Accenture and DTCC, with support from Digital Asset and DLT consortium R3, and seemed to demonstrate that DLT networks have the capacity to support the sort of trading volumes seen on US equity markets.

Accenture and DTCC’s prototype platform processed more than 100m trades per day.

While the number is impressive, the platform will have to jump through additional hoops before it can be approved by regulators. For example, during a stress event, the platform will have to be able to handle far higher volumes still.

But the study is a rebuke of the conventional wisdom that says a distributed ledger by its very nature is unable to be as scaleable or as fast as specially designed conventional networks.

Jennifer Peve, managing director, fintech strategy at DTCC, told Byte Me that the results of the tests were “encouraging”, but that there was still work to be done.

“We need to assess how smart contract functionality impacts overall latency and scalability of the network, in addition to the data privacy and sharing aspects of the ledger,” she said. 

Smart contracts either partly or completely self-execute without human intervention.

DTCC might be working towards an efficient, secure network, but the grand vision of a truly decentralised network is a long way off. Of course, it is not clear that a truly decentralised network is desirable for US equity markets anyway.

“Having a central entity that can provide the roles, responsibilities and rules of the network and oversee the deployment of the new technology adds value,” said Peve.

This stands in direct contrast to many cryptocurrencies that rely on software updates from a dedicated team of core developers, which are then approved by the so-called “miners” that use the software to approve transactions.

While this system can allow for greater decentralisation and the elimination of large intermediaries, it can be chaotic and difficult to scale, resulting in slower transaction times. Miners and software developers need to agree on changes to the network too, which can take time.

It’s clear that we are some ways away from a DLT revolution of financial markets, and if it does occur, it may not materialise in the manner blockchain enthusiasts expect.

But distributed ledger technology is not an end in itself and should only pursued to the extent that it provides tangible benefits for doing business.