Stable cryptocurrencies as a medium of exchange
Guest post by Peter Petrovics, www.augmint.cc
Peter has launched multiple startups including founding Hungary’s no.1 social network iWiW (launched in 2002 before Facebook/MySpace/Friendster) and Virgo Systems and is currently the cofounder of Augmint
Why is the mass adoption of crypto payments stalling?
Among multiple challenges, the biggest barrier to widespread use of cryptocurrencies in everyday transactions is their high price volatility. Which merchant or service provider would take the risk offsetting a price and earning revenues in Bitcoin (BTC) when their costs are in a real world currency?
In the land of cryptocurrencies, high volatility is an ordinary event and that’s why the evolution of stable cryptocurrencies are so important
When a 10%-20% price movement or more is normal in any given day, it is hard to create a stable economy. Financially it would be hard to live in a world where a highly volatile asset is the main currency.
Who would agree to pay rent in Bitcoin when their salary is paid in dollars or pounds?
Who would get a mortgage denominated in Bitcoin when their salary is in pounds or euros? As it is today, already an increasing number of DApps rely on ether and the Ethereum network where a bigger price volatility could easily cause complications in the system. We mostly agree that it is essential to have a cryptocurrency with a reasonably stable price to keep the decentralised, smart contract economy rolling.
And that is the main challenge facing us right now…
What is the best way to build a stable coin that could bypass the wild crypto price movement, market speculations and create the backbone of the internet of value?
Beyond multiple attempts to create a stable cryptocurrency, several projects are on the horizon which are aiming to decentralize money creation and even starting to apply credit money attributes in their schemes. There are potentially four models which might be suitably designed for the creation of a stable cryptocurrency: the fiat-collateralized, crypto-collateralized, non-collateralized and the asset-backed cryptocurrencies.
One of the easier way to create a stable cryptocurrency is the fiat-backed cryptocurrency whereby the organisation deposits their real world paper money (“fiat”) into a bank account and the fiat pegged coin or token is issued on a one to one ratio. The digital token has value because it represents a claim on another asset with some defined value. When the holder wants to convert the stable coin back into the fiat currency, then the issuer destroys the stable coin and transfers the fiat currency back to the owner. This bank deposit tokenization approach has some drawbacks such as trust from the issuing party, that the issuer actually holds the fiat collateral and that they are willing to honour the IOUs.
Tether is one of the widely known fiat-backed stable coin, but, as a whole, it’s not really considered a cryptocurrency, rather a company for several reasons: There are owners of this organisation, Tether is a registered company, the owners of Tether have complete control over the money supply and they could potentially fork the project in a new direction.
Fiat-collateralized stable coin examples
The second potential model on the list is the crypto-collateralized stablecoin. This model has no fiat currency connection, all the possible collaterals are on the blockchain, such as Bitcoin, Ethereum or other cryptocurrencies. These collaterals are locked into a smart contract, so there is no third party involved, the structure is more decentralized.
Furthermore, if the system designed well, it can be completely decentralized, making crypto-collateralized stablecoins more appealing to people than the fiat-collateralized cryptocurrencies.
On the other hand, the drawback of this model is the high volatility of the collateral. The system requires a substantially higher amount of collateral in order to make the lending or transaction bulletproof. As an example, if a person or an organization (let’s call it a user) needs 100 USD worth of crypto-USD, then the user needs to lock 150%-300% worth of ETH as a collateral in order to eliminate the obstacles of volatility. The smart contract, where the collateral is locked into, allows the users to access it by paying back the stablecoin debt or can be sold by the system if the collateral exchange rate falls below a certain point.
High collateral ratio is clearly an issue in the system, however, as the cryptocurrency ecosystem is getting more mature, several solutions appear on the horizon. Asset-backed tokens could be a good collateral option through their less volatile nature. There are already great progress on this field and predictions indicate that 10% of global GDP will be stored on blockchain by 2025 as tokenized assets.
Crypto Collateralized examples:
The third model is the non-collateral stable coins or the so-called seigniorage shares. As its name says, this approach is not actually backed by anything other than confident belief that it will keep the promised value. Non-collateral stable coins scheme was invented by Robert Sams in 2014 where, its algorithm is controlling the supply of the coin, similar way as central banks do with fiat money.
As an example, take a non-collateral stable coin which pegged to 1USD. Given fixed supply, an increase in demand will cause the price to increase. Due to algorithmic setup, the system would issue more stable coin and sell it to the market resulting a price drop to the targeted 1USD.
On the other hand, when the demand decreases, the price also drops below the targeted 1USD. In most cases, the system is not able to buy back a sufficient amount of coins, therefore in order to reduce the circulating supply, the system issues shares or/and bonds with a par value of 1USD that are sold with discount in order to make it more appeal for users. In this case, bondholders are reducing stablecoins from the market, reducing supply, and raising the price.
As soon as the price rises above the targeted value, the system will favour the bondholders and shareholders first and pays them out (in a chronological order).
When the non-collateral stablecoin system is observed closely, it shows some similarities to the pyramid scheme. When the price is below the targeted level, the only support that might generate a successful rally is the promise of a future growth, which can be maintained by a higher market demand. As soon as a continuous growth can’t be maintained, the stablecoin and bondholders might be in a serious trouble. And here is why: As the price of the stablecoin falls, the system issues more bonds to raise the price. As more bonds the system issues, the longer the bond queue will be. As the bond queue is longer, the more time it needs to get paid (they are getting paid by chronological order, as it was mentioned above) and decreases the likelihood that each bond is paid. As the risk is higher, the bonds price must be lower to offset the additional risks. As the price of the bonds falls, more bonds are needed in order to shorten the supply of stablecoin. Users will lose faith in the stablecoin, stop using it and this will further push down the price and trigger a death spiral.
Non-Collateralized stablecoin examples:
Let’s start with assets. Real assets are tangible or intangible economic resources that can be converted into cash. Tangible assets can be things such as gold or real estate while intangible assets are bonds, stocks or even bitcoin. Intangible assets are traded with its potential future worth, they can be much more valuable than tangible assets, therefore also more volatile. Since stability is most of the asset-backed cryptocurrencies aim, they are pegged to a tangible asset. This means that each token is worth exactly as much as the agreed unit of the physical asset, in other words the token price depends on the supply and demand fundamentals for the underlying asset.
Asset backed crypto currencies are differ a bit from the last three, because It is lacking of the characteristics of a currency.
Asset-backed tokens are a good store of value, an excellent solution for investors to protect their portfolio during volatile periods and it is also a feasible solution to protect wealth from inflation. You could buy 100 USD worth of goods for just 5.56 USD in 1915. That’s how much value the USD has lost in the past hundred of years. Assets such as gold has historically been an excellent hedge against inflation because its price tends to rise when the cost of living increases. Over the past 100 years investors have seen gold prices soar and the stock market plunge during high-inflation years.
Asset backed cryptocurrencies could be good as a medium of exchange, although it is not a natural approach. Money is a particular type of asset in an economy that people use to buy goods and services from other people or businesses. A medium of exchange is something that buyers will exchange with a seller when they want to purchase goods or services from the seller. While many things could be used as a medium of exchange in an economy, money is the most common and useful medium of exchange in our society.
A unit of account in economics is a nominal monetary unit of measure or currency used to represent the real value of any economic item; goods, services, assets, liabilities, income, expenses. Even though an asset-backed stable coin might have a lower volatility than other cryptocurrencies, it is still not good as a unit of account, which provides a common base for prices.
Asset Backed examples:
The cryptocurrency ecosystem is in a desperate need for a stable digital currency with the benefits of digital tokens in the form of a unit which can be used in the various blockchain use cases for payments, planning, in smart contracts and holding value in a relatively stable digital form.
With that in mind, Augmint is going to offer an independent, transparent, open source Digital Autonomous Organisation (DAO) and stable cryptocurrencies as a medium of exchange. On the technical point of view, Augmint’s focus is on three keys attributes: decentralization, a wide variety of collaterals with a low collateral ratio, and a unique platform for a scalable crypto-fiat pair creation. To get more familiar with the project, please check out our white paper and website. Please follow us on social media and if you have any question just shoot it on Discord.
Augmint’s model is based on the crypto-collateral method. The system is designed in a way that it’s functionality is decentralized and trustless, it’s diversified and broad base of collaterals make the system usable and it’s unique platform makes the system scalable.
Augmint aspires to be the world’s digital payment token. It is considered to be viable only with a system where no single group is able to take control and new stakeholders can join the decision making quorum simultaneously. Augmint propose a structure that ensures open and democratic governance in the long run.
The project will be maintained by an open community of financial and technology experts, financed by the stakeholders. The fundamental rules are set out in the Augmint manifesto.