September 12, 2019 Reading Time: 5 minutes

As stablecoins continue developing, are they driving new innovation or rehashing old, failed ideas?

Cryptocurrencies and cryptoassets burst into the mainstream with a spectacular run-up in the price of bitcoin during the second half of 2017, with a 2019 market study showing that now over 50% of all Americans are aware of bitcoin.

With over 750,000 BTC involved in transactions during an otherwise unremarkable September 2019 week, and 11% — or approximately 36 million —  Americans owning BTC, the question needs to be asked: what’s next?

Bitcoin has gone from buzzworthy to mundane, disillusioning many as it became clear that the original mandate to disrupt everyday financial transactions never came to be. This BTC disillusionment, and current pivot toward stablecoins, was driven by and reflective of the impact price volatility had on the BTC market. Stablecoin development and adoption is a direct result of how the price euphoria in 2017 fractured and weakened the use case of BTC as a viable currency tool.

The 2017 increase in price, driving awareness and increased ownership, also exposed a flaw in the BTC blockchain model. Conducting transactions on the original bitcoin blockchain simply became too expensive, were slower than before, and fractured the nascent retail community of adopters. 

This same spectacular run-up in price during 2017 benefitted early adopters and investors, but crushed consumer use of BTC, and was a major force driving the fork that resulted in both Bitcoin and Bitcoin Cash. This initial fork, in turn, has resulted in additional forks seemingly more focused on developer preference than efficient yet decentralized financial transactions. 

The fracturing of the BTC market, and the HODL community treating cryptocurrencies as investments and not currency, opened the door for incumbent financial institutions to launch peer-to-peer and mobile first lending/transactional products such as Zelle and Venmo.

These peer-to-peer platforms led to the following question: is there a way to have an asset running on a blockchain that can, at the same time, function for everyday consumer and transactional use? 

This market need is what stablecoins were developed to solve. Developed as a halfway point between decentralized crypto like BTC, and centrally governed fiat like the USD, these hybrid instruments have rapidly developed. 

Stablecoins, however, are not the same as traditional cryptocurrencies; they may be leading the cryptoasset landscape in a direction paradoxical to the intent of bitcoin, and could eventually centralize control over cryptoassets in the hands of the very incumbents blockchain was developed to disrupt. 

The fine print matters, and it especially matters for cryptoassets.

The fact that every stablecoin, including USDT, to date has either been issued by a private organization or is state- sanctioned would seem to provide an additional layer of comfort to regulators, institutions, or potential users. Stablecoins, on paper, provide solutions to both issues by encouraging greater adoption, and by potentially assuaging the fears of regulators.

If the analysis stopped here, the economic case for stablecoins seems very clear cut: encouraging mass market adoption and the creation of products allowing greater accessibility to a new asset class. 

There is a risk, however, that as stablecoins gain market share and acceptance, their market, pricing, and governance power becomes concentrated in the hands of a few institutions. Why that matters, in the bigger picture, can be illustrated as follows.

If a company operating with a government backstop, group of organizations, or state-sponsored actor issues a cryptographically secured currency, secured and supported by either external assets or guarantee, and the issuance of additional units is governed by the entity, is that really all that much different from the fiat currencies that currently exist? If so, what will that mean for the future of both traditional cryptocurrencies and stablecoins? 

Let’s first address a fundamental concern: are cryptoassets actually functioning as advertised? A recent statement by a Tether co-founder said it might not always be necessary for every USDT to be backed by a corresponding USD. This highlights a potential risk. If stablecoins are not actually supported by external assets, but rather a promise or belief, how are they different from current fiat currencies?

But despite these potential existential risks to the ethos of blockchain, development continues to accelerate. Spearheaded by Tether, which may have — and may continue to be doing so — serve as an unofficial proxy for a central bank in the cryptocurrency space, the stablecoin space continues to rapidly develop. As of September 2019, the 24-hour trading volume for Tether hovers around the USD equivalent of $16 billion, and while USDT continues to dominate trading volume in the stablecoin space, several other high profile entrants are aggressively pursuing crypto products and services in conversation with regulators. These products include attempting to launch crypto ETFs and custodial services, which by themselves represent potential game-changers in the space.

This begs the following questions. First, why are these various stablecoins so appealing to institutional players? And second, does the entrance of established financial and technology institutions post a paradox to the ethos of decentralization associated with blockchain and cryptoassets.

The very label of stablecoin efficiently communicates a core value proposition of what stablecoins purport to offer the cryptoasset ecosystem. Reduced, or at least more predictable, price volatility could — in theory — lead to broader based adoption of these cryptoassets as a viable and sustainable alternative to fiat currency. This, it is important to remember, was the goal of early adopters and remains the goal of many cryptoasset holders.

Building on this core value proposition, is the thought that this reduced volatility will also lead to increased crypto productization, which to date has remained stymied in the United States with no true crypto ETFs being approved as of mid-September 2019. Regulators continue to cite the underlying price volatility of bitcoin as a reason to deny ETF applications. The fact that price volatility in BTC has dropped by over 50% since early Q3 2019, and that bitcoin continues to have billions in transactions every week has not persuaded the SEC as of yet.

Ironically this reduced price volatility, repeating stabilization that has previously occurred at other price levels, may eventually, if it holds, temper enthusiasm for stablecoins. 

Recapping the differentiation, stablecoins can 1) have lower price volatility, 2) help encourage greater usage and maturation from a use case and productization perspective due to this lower volatility, and 3) have increased transparency due to the fact that there is, in fact, a person or governing association in charge of resolving issues. That said, the shift toward this increased centralization and integration with current regulations also poses an apparent paradox.

The bitcoin blockchain, the blockchain that kickstarted this entire ecosystem, was initially designed to disintermediate financial institutions. Those very same financial institutions, and new organizations offering centralized stablecoin offerings, are increasingly playing a large role in the cryptoassets conversation.

Now, a dialogue, relationship, and engagement between financial institutions and the governments, which in many cases provide an indirect or explicit backstop, is an inevitable and logical evolution as this financial asset class continues to develop. Some kind of standardization and investor protection frameworks should not be viewed with hostility, but rather as a sign of greater acceptance and understanding of the value of both blockchain and cryptoassets.

The following issue, however, remains. As stablecoins develop, mature, and have increased adoption, they might not be driving continued innovation in the crypto space so much as simply rehashing current ideas in a new package.

Sean Stein Smith

Sean Stein Smith was a Visiting Research Fellow at the American Institute for Economic Research, focusing on blockchain, cryptoassets, and the economic impact of these technologies. He is an Assistant Professor at the City University of New York (Lehman College), serves on the Advisory Board of Wall Street Blockchain Alliance, where he also chairs the Accounting Working Group, and chairs the Emerging Technology Interest Group of the New Jersey Society of CPAs.  His research has been quoted in dozens of scholarly and practitioner publications, and he is a regular speaker at accounting and technology conferences. Follow him on Twitter.

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