Bernard Lunn
If you are trader/speculator, volatility is your friend. If you are using Tokenomics to fund a venture, volatility is also your friend; you sell Tokens into a rising market in order to fund the business. There are other situations where volatility is your enemy and stability is your friend. A new generation of Stablecoins are entering the market to meet these needs.
This is Part Three (Chapter 5) of The Blockchain Economy serialised book. Part Three is where we focus on investing in the Blockchain Economy. This Chapter focusses on Investing in Payment Tokens and Stablecoins (aka new currencies). For the index/table of contents of The Blockchain Economy book please click here.
Future chapters in Investing in The Blockchain Economy will cover:
• Ethical Investing via Tokenomics. Scheduled for 11 August. The last Chapter in Part 3 of this book.
This Chapter describes:
- Three use cases for a Stablecoin
- Three types of Stablecoin assets
- Two types of Stablecoin peg models
- Three revenue models for Stablecoins
- The regulatory backdrop
Three use cases for a Stablecoin
- Tool for traders. A Stablecoin offers a place to park your crypto assets without cashing back into Fiat. For example, Tether/USDT is pegged to the US Dollar but is a crypto asset. Tether/USDT is currently the biggest Stablecoin. The obvious question is why would anybody want Tether/USDT rather than simply owning Traditional US Dollars? This is use case number 1. For example, if you have some crypto assets, but are bearish on short term trends, you could trade those crypto assets back into US Dollars, but that costs a lot in fees and taxes. Trading Fiat to Crypto or Crypto to Fiat is expensive. In contrast, trading Crypto to Crypto is cheap. So you exchange your crypto assets for USDT until you want to buy back into the market. Tether is a single currency coin (US Dollar) and the buyers are not betting long term on the US Dollar, they are simply betting that it will stay stable long enough to move back into other crypto assets.
- Long term asset stability for investors. This is for people investing for a long time horizon such as Family Offices. For example, if you are bearish on short term trends in traditional securities, you might want to go to cash or short term debt. Nobody would buy something like USDT for this purpose as it would be much easier to simply buy traditional US Dollars; but they might buy one of the new breed of multi-asset stable coins (see next section) or a coin that is backed by an asset that is independent of any Fiat currency.
- Currency to facilitate cross border payments. Bitcoin was originally conceived as a 3 legged stool (1 = store of value, 2 = currency for everyday payments 3 = interim store of value to facilitate payments). Store of value is well proven (Bitcoin as digital gold) but Bitcoin is too volatile today to be a payment rail or currency for everyday payments. If you wanted a currency for this purpose, you would create something that was almost a mirror image of Bitcoin, with the lowest possible volatility against the major Fiat Currencies. This needs one of the new breed of Multi-Fiat Peg Stable coins
Three Types of Stablecoin assets
- Single Fiat Peg (usually the US Dollar can be EUR or Yen). Tether/USDT is the big one that has been operating for some time, but has been more recently been joined by TrueUSD/TUSD and Havven/HAV.
- Multi Fiat Peg. These use a basket of Fiat currencies possibly with some non Fiat hard assets. Single Fiat Peg is adequate for use case 1 = a place to park your crypto assets without cashing back into Fiat; so it is no surprise that Crypto Exchanges use them as a way to encourage trading. However, a Single Fiat Peg is no use to somebody looking for use case 2 = long term asset stability; many global investors look at US$ as a long term risk factor. For use case 3 = currency to facilitate cross border payments, a Multi Fiat Peg is also less volatile.
- Tokenised single hard asset. These are assets that have low correlation with Fiat currencies and Traditional Securities. We cover these in more detail in Part 3/Chapter 4 = Tokenised Real World Assets (fractional ownership of some “hard value” asset). There are already more than 10 backed by Gold.
Two Types of Stablecoin peg models
- Deposits held in custody. This is the most popular and easy to understand and used by most Stablecoins. For example, Tether/USDT pegs to the US Dollar via reserves held in custody. So if you buy $1 of USDT, you are told that it is backed by $1 of US Dollar held in a bank. This obviously requires some confidence that the Stablecoin operator really does have the assets properly custodised; for a while there was serious concern that Tether/USDT was doing this. Confidence measures include an audit by a reputable firm. Even while there was serious concern that Tether/USDT was really holding assets in reserve, the peg remained fairly stable; if your use case is for short term trading you are less concerned. Stablecoins will increasingly fall under regulatory scrutiny as they are deposit taking and need at least AML/KYC processes.
- Model based. This is simply an information service. The model is published (data and algos) and partners can use in their applications and some partners may choose to offer a collateralised service.
Note: modern trading is algo model driven. So a Stablecoin may look like it is model based because they use algos and models to trade in an out in order to maintain the peg.
3 revenue models for Stablecoins
Many Stablecoin ventures recently got VC funding and there are many ways for Stablecoins to make money, including:
- Provider to multiple exchanges. Tether/USDT, the leading Stablecoin, is owned by Bitfinex, a Crypto Exchange. The business logic is simple. A Stablecoin facilitates active trading and Crypto Exchanges make their money from active trading. There is no reason for each Crypto Exchange to manage their own Stablecoin.
- Fund for wealth managers. This is where a Multi Fiat Peg asset is needed as most wealth managers will advise against excess exposure to a single currency.
- Tool for payment services. If you operate a cross border payment service, a Stablecoin is a key component, so that you are not reliant on Legacy FX exchange services.
One business model that does NOT work with Stablecoins is Token Sale Funding (sometimes called Tokenomics). This is the model where the entrepreneur funds the venture by selling tokens at ever higher prices. The whole point of a Stablecoin - price stability - runs counter to this. This is not needed as those 3 revenue models for Stablecoins are enough for them to make money from customers.
The regulatory backdrop
Stablecoins attract the attention of regulators for two reasons:
- Collateralised Stablecoins are deposit takers and that is a magnet for scammers and needs regulatory oversight.
- Stablecoins can facilitate the on/off ramps from/to Fiat/Crypto and that is a magnet for money launderers and needs regulatory oversight.
One question is - which regulator? A Stablecoin is currency and needs regulator who has oversight of currencies. For example, in the USA this is NOT the SEC which is taking action on other Tokens but does not have regulatory oversight of currencies.
Another question is - which jurisdiction? A Stablecoin is naturally global and not tied to any single currency. It maybe perceived as a threat to agencies that manage domestic Fiat currencies.This is where Switzerland is interesting for two reasons:
- FINMA, regulates Tokens depending on their use case. They define 3 (Payment, Utility, Asset). So there is a regulatory framework specific to Payment Tokens. (FINMA is the Swiss financial regulator).
- Switzerland is legally a multi-currency country. What? We all know Switzerland is multi-language, but we also know the famous Swiss Franc. It turns out that there is an alternative currency called WIR that was set up in 1934 that is quite legal. The WIR was set up by people wanting to create an alternative to a financial system that had failed so dramatically in 1929. This has echoes from 2008 and the Satoshi Nakamoto White Paper. WIR accounts for a tiny % of Swiss GDP but it is real and legal. So the idea of adding another legal currency was not too big a stretch. That is why you can pay taxes in Bitcoin in Swiyzerland and buy Bitcoin at any railway ticket machine. It is also why a Stablecoin that plays by the rules can be a legal currency in Switzerland.
Bernard Lunn is the CEO of Daily Fintech and provides advisory services to companies involved with Fintech (reach out to julia at daily fintech dot com to discuss his services).
This is Part Three (Chapter 5) of The Blockchain Economy serialised book. Part Three is where we focus on investing in the Blockchain Economy. This Chapter focusses on Investing in Payment Tokens and Stablecoins (aka new currencies). For the index/table of contents of The Blockchain Economy book please click here.
Future chapters in Investing in The Blockchain Economy will cover:
• Ethical Investing via Tokenomics. Scheduled for 11 August. The last Chapter in Part 3 of this book.
This Chapter describes:
- Three use cases for a Stablecoin
- Three types of Stablecoin assets
- Two types of Stablecoin peg models
- Three revenue models for Stablecoins
- The regulatory backdrop
Three use cases for a Stablecoin
- Tool for traders. A Stablecoin offers a place to park your crypto assets without cashing back into Fiat. For example, Tether/USDT is pegged to the US Dollar but is a crypto asset. Tether/USDT is currently the biggest Stablecoin. The obvious question is why would anybody want Tether/USDT rather than simply owning Traditional US Dollars? This is use case number 1. For example, if you have some crypto assets, but are bearish on short term trends, you could trade those crypto assets back into US Dollars, but that costs a lot in fees and taxes. Trading Fiat to Crypto or Crypto to Fiat is expensive. In contrast, trading Crypto to Crypto is cheap. So you exchange your crypto assets for USDT until you want to buy back into the market. Tether is a single currency coin (US Dollar) and the buyers are not betting long term on the US Dollar, they are simply betting that it will stay stable long enough to move back into other crypto assets.
- Long term asset stability for investors. This is for people investing for a long time horizon such as Family Offices. For example, if you are bearish on short term trends in traditional securities, you might want to go to cash or short term debt. Nobody would buy something like USDT for this purpose as it would be much easier to simply buy traditional US Dollars; but they might buy one of the new breed of multi-asset stable coins (see next section) or a coin that is backed by an asset that is independent of any Fiat currency.
- Currency to facilitate cross border payments. Bitcoin was originally conceived as a 3 legged stool (1 = store of value, 2 = currency for everyday payments 3 = interim store of value to facilitate payments). Store of value is well proven (Bitcoin as digital gold) but Bitcoin is too volatile today to be a payment rail or currency for everyday payments. If you wanted a currency for this purpose, you would create something that was almost a mirror image of Bitcoin, with the lowest possible volatility against the major Fiat Currencies. This needs one of the new breed of Multi-Fiat Peg Stable coins
Three Types of Stablecoin assets
- Single Fiat Peg (usually the US Dollar can be EUR or Yen). Tether/USDT is the big one that has been operating for some time, but has been more recently been joined by TrueUSD/TUSD and Havven/HAV.
- Multi Fiat Peg. These use a basket of Fiat currencies possibly with some non Fiat hard assets. Single Fiat Peg is adequate for use case 1 = a place to park your crypto assets without cashing back into Fiat; so it is no surprise that Crypto Exchanges use them as a way to encourage trading. However, a Single Fiat Peg is no use to somebody looking for use case 2 = long term asset stability; many global investors look at US$ as a long term risk factor. For use case 3 = currency to facilitate cross border payments, a Multi Fiat Peg is also less volatile.
- Tokenised single hard asset. These are assets that have low correlation with Fiat currencies and Traditional Securities. We cover these in more detail in Part 3/Chapter 4 = Tokenised Real World Assets (fractional ownership of some “hard value” asset). There are already more than 10 backed by Gold.
Two Types of Stablecoin peg models
- Deposits held in custody. This is the most popular and easy to understand and used by most Stablecoins. For example, Tether/USDT pegs to the US Dollar via reserves held in custody. So if you buy $1 of USDT, you are told that it is backed by $1 of US Dollar held in a bank. This obviously requires some confidence that the Stablecoin operator really does have the assets properly custodised; for a while there was serious concern that Tether/USDT was doing this. Confidence measures include an audit by a reputable firm. Even while there was serious concern that Tether/USDT was really holding assets in reserve, the peg remained fairly stable; if your use case is for short term trading you are less concerned. Stablecoins will increasingly fall under regulatory scrutiny as they are deposit taking and need at least AML/KYC processes.
- Model based. This is simply an information service. The model is published (data and algos) and partners can use in their applications and some partners may choose to offer a collateralised service.
Note: modern trading is algo model driven. So a Stablecoin may look like it is model based because they use algos and models to trade in an out in order to maintain the peg.
3 revenue models for Stablecoins
Many Stablecoin ventures recently got VC funding and there are many ways for Stablecoins to make money, including:
- Provider to multiple exchanges. Tether/USDT, the leading Stablecoin, is owned by Bitfinex, a Crypto Exchange. The business logic is simple. A Stablecoin facilitates active trading and Crypto Exchanges make their money from active trading. There is no reason for each Crypto Exchange to manage their own Stablecoin.
- Fund for wealth managers. This is where a Multi Fiat Peg asset is needed as most wealth managers will advise against excess exposure to a single currency.
- Tool for payment services. If you operate a cross border payment service, a Stablecoin is a key component, so that you are not reliant on Legacy FX exchange services.
One business model that does NOT work with Stablecoins is Token Sale Funding (sometimes called Tokenomics). This is the model where the entrepreneur funds the venture by selling tokens at ever higher prices. The whole point of a Stablecoin - price stability - runs counter to this. This is not needed as those 3 revenue models for Stablecoins are enough for them to make money from customers.
The regulatory backdrop
Stablecoins attract the attention of regulators for two reasons:
- Collateralised Stablecoins are deposit takers and that is a magnet for scammers and needs regulatory oversight.
- Stablecoins can facilitate the on/off ramps from/to Fiat/Crypto and that is a magnet for money launderers and needs regulatory oversight.
One question is - which regulator? A Stablecoin is currency and needs regulator who has oversight of currencies. For example, in the USA this is NOT the SEC which is taking action on other Tokens but does not have regulatory oversight of currencies.
Another question is - which jurisdiction? A Stablecoin is naturally global and not tied to any single currency. It maybe perceived as a threat to agencies that manage domestic Fiat currencies.This is where Switzerland is interesting for two reasons:
- FINMA, regulates Tokens depending on their use case. They define 3 (Payment, Utility, Asset). So there is a regulatory framework specific to Payment Tokens. (FINMA is the Swiss financial regulator).
- Switzerland is legally a multi-currency country. What? We all know Switzerland is multi-language, but we also know the famous Swiss Franc. It turns out that there is an alternative currency called WIR that was set up in 1934 that is quite legal. The WIR was set up by people wanting to create an alternative to a financial system that had failed so dramatically in 1929. This has echoes from 2008 and the Satoshi Nakamoto White Paper. WIR accounts for a tiny % of Swiss GDP but it is real and legal. So the idea of adding another legal currency was not too big a stretch. That is why you can pay taxes in Bitcoin in Swiyzerland and buy Bitcoin at any railway ticket machine. It is also why a Stablecoin that plays by the rules can be a legal currency in Switzerland.
Bernard Lunn is the CEO of Daily Fintech and provides advisory services to companies involved with Fintech (reach out to julia at daily fintech dot com to discuss his services).
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