Last time we talked about algorithmic stablecoins,
and it was disappointing. The most promising algorithmic stablecoin failed due to regulation
problems. So it might not amount to anything. But this video will be different.
Now it’s time to focus on the other 2 types. Namely: crypto-collateralized and fiat-collateralized
stablecoins. And we shall see if it really is the holy grail of crypto!
Hello Cryptogang! Welcome to another LamboLife video.
Collateralized stablecoins differ from algorithmic in the sense that they are backed by assets.
You could use cash, precious metals, cryptocurrencies, or even other stablecoins as collateral.
The most obvious way to create a stablecoin is to use fiat money; AKA a government approved
currency like the dollar. It’s pretty straightforward. You just create a new currency that is redeemable
by a popular and stable currency. For instance, you want to create stablecoin
pegged to the US dollar; therefore, you should deposit dollar cash into a bank account and
issue stablecoins with a 1 to 1 ratio against those dollars. And that’s it. You now have
a fiat-collateralized stablecoin. But what if a user wants to liquidate their
stablecoins back into fiat? How do we ensure it’s still stable?
Well, if there is a minus in demand, there should be an equal minus in supply. That’s
how you keep the balance. So if a user wants to cash out, we burn their coins and wire
them the dollar equivalent. This scheme should definitely be stable. — almost
like it’s really a digital representation of a dollar.
This might be the simplest way to build stablecoins but it has some drawbacks. It requires centralization
of the ledger, which is against most of our collective values. Coz users have to trust
the custodian. And they have to ensure that the custodian is trustworthy.
Not only that, but the project would need to be audited regularly, and for the founders,
this might be expensive to maintain. Now centralization might be unfavourable but it surely has its
perks. This type of stablecoin can withstand any
cryptocurrency volatility, because all of the collateral is held in cash reserves and
will remain intact in the event of a crypto crash. This isn’t true for the other stablecoins.
Even algorithmic stablecoins would be affected in a downtrend market.
However, if the currency that backs the stablecoins crashes, then you’re in a world of hell.
So it’s important for stablecoins to choose a fiat currency that is robust. Not like Venezuelan
bolivar, which fell by 10,000,000 percent. Gosh! That’s painful.
But even with the dollar, it’s still not completely safe though.
And I’m saying this because I remember what John Mcafee said before. Why he was willing
to bet cutting off his manhood if Bitcoin doesn’t hit 1million dollars by 2020. And
it was because he was considering not only the growth and popularity of Bitcoin as a
store value and payment system, but also the devaluation and deterioration of the dollar
and other major fiat currencies. Now I’m not too sure about Bitcoin hitting a million
dollars anytime soon, but I do believe that the growth of Bitcoin will be proportional
to the decline of major currencies. That’s just basic economic logic. Less demand for
the dollar will cause it to plummet in price. With that in mind, I wouldn’t feel too safe,
storing a chucnk of my savings on tether. Even though tether is the most popular stablecoin.
About 50 percent of the trading volume of stablecoins belong to tether. And I’m not
entirely sure why it’s still the most trusted stablecoin to be honest, coz they have a lot
to answer for. They failed to have their cash reserves audited,
even though they promised to. A lot of people pointed out their discretion. Until they finally
admit, that they do not have all the cash that they claimed.
However, it still says on their website that all their stablecoins are backed; but not
all cash. They now include other assets and receivable from loans made by third parties.
But they never admit this before, only around this year. So to all tether users I’m not
saying you shouldn’t use tether; But, if you do, watch them closely. Don’t
ever feel safe. Just don’t. Based on their behaviour, you shouldn’t fully trust Tether
Company. Now, fiat-backed schemes are heavily regulated
and constrained by traditional payment rails. If you want to exit back to fiat, you’ll
likely need to wire money or mail checks; which is a slow and expensive process. Besides Tether, there are many other stablecoins.
A good example is TrueUSD, which is a more transparent counterpart. Unfortunately, their
trading volume of 40 million is dwarfed by Tether’s 12 billion per day.
But Tether’s biggest competition among its category would be USD Coin, a recent stablecoin
brought to you by Coinbase and Circle. Well, I guess a lot of people still use Coinbase.
I don’t but I guess this gives the coin more credibility. Coinbase, afterall, has
a lot of liquidity so they can manage their reserves better. Current trading volume is
over 2 billion dollars. But they’re not the only exchange with a
stablecoin. Gemini has their own Gemini dollar too. Pick your poision guys.
By the way, this type of stablecoin works with other assets as well. For instance, gold;
just like Digix Gold, a stablecoin that represents physical gold with DGX tokens, where 1 DGX
represents 1 gram of gold. It shares the same fundamental properties with fiat-collateralized
coins, but instead of fiat, it’s gold. There are other precious metal-backed stablecoins
as well. Suppose we don’t want to integrate with
the traditional payment systems. After all, this is new money. We just reinvented it.
Why go back to centralized banks and state-backed currencies?
If we move away from fiat, we are able to remove centralization.
The idea is this; we do the same thing we did with fiat-backed stablecoins, but instead
of USD or another currency, we back our coin with reserves of a cryptocurrency. That way,
everything can be on the blockchain. Now you’re thinking, but cryptocurrencies
are definitely unstable; our stablecoin would fluctuate up and down. And that’s right.
So here’s what we gonna do. We’re gonna over-collateralize, that is
to say, back our stablecoin with more collateral than its circulating supply. This is the opposite
of fractional reserve banking, where bankers have less cash than the circulating supply
of their money. So this stablecoin scheme is more virtuous, in a sense.. yeah word.
Anyway, since the value of our collateral is more than the circulating supply of our
stablecoin, it can absorb price fluctuations of the collateral.
For instance, suppose we have a stablecoin called Lambocoin.
Suppose we deposit 200 dollars worth of Ether and then issue 100 $1 Lambocoins against it.
So, since we now have 100 dollars worth of Lambo coins backed by 200 dollars’ worth
of Ether. That means we are 200 percent collateralized This means the price of Ether can drop by
25 percent, and our Lambocoins will still be safely collateralized by 150 dollars’
worth of Ether, and can still be valued at 1 dollar each.
And if we choose to, we can liquidate them now, giving 100 dollars in Ether to the owner
of the Lambocoins, and the remaining 50 dollars in Ether back to the original depositor.
Now you’re probably thinking, neat trick, but why would anyone create a stablecoin like
that? Surely, by the structure itself, this scheme is capital intensive. There has to
be a reward to incentivize the creator to risk it.
Well, there are two incentives you can use here. First, you could pay the issuer interest,
which some schemes do. Or, the issuer could choose to create the extra stablecoins as
a form of leverage. Let’s use Lambocoins again in this context.
This may be a little hard to grasp, but here’s how it works: if a depositor locks up 200
dollars of Ether, they can create 100 dollars of Lambocoins. Then, they sell those 100 Lambocoins
on the market in exchange for 100 dollars’ worth of Ether.
Now, they have a leveraged position of 300 dollars’ worth of Ether, backed by 200 dollars
in collateral. If Ether goes up by 200 percent, they woul have 600 dollars, instead of the
400 dollars they’d otherwise make. Is it clear so far.
Basically, all crypto-collateralized stablecoins use some variation of this scheme. You over-collateralize
the coin using another cryptocurrency, and if the price drops enough, the stablecoins
get liquidated. All of this can be managed on the blockchain in a decentralized way.
But, there’s a minor catch. The stablecoin has to know the current USD to Ether trading
price. And blockchains are unable to access any data from the external world. So how can
we know the current price, then? This is where the so-called oracles come in.
An oracle is someone who finds and verifies real-world data and submits this information
to a blockchain via smart contracts. So, we could simply have an oracle to continually
publish a price feed onto the blockchain. But apparently, this is vulnerable to manipulation,
so the publisher needs to be trustworthy. Another way is to use the Schelling Coin scheme,
which is much more complex and requires a lot of coordination, but is ultimately less
centralized and less prone to manipulation. An example for this is Truthcoin, which present
an “oracle corporation” model, which guarantees that a group of self-selected, anonymous,
greedy users will always resolve contract-outcomes honestly. The first stablecoin to use the crypto-collalleteralized
scheme was BitUSD, which collateralized with BitShares, back in 2013.
The most popular and most promising one today, would have to be MakerDAO’s platform, which
is collateralized by Ether. The Makerdao platform has two tokens; First is Dai, the stablecoin,
then there’s Maker, it’s not a stablecoin; its main purpose is to govern the Maker Platform.
Expect a full video about MakerDAO soon, coz this project gives me goosebumps. Expect great
things from DAI. With that being said, there are still some
drawbacks that we need to consider. Crypto-collateralized stablecoins are more vulnerable to price instability
than their fiat counterparts. With fiat it’s less risky since they are inherently less
volatile to begin with. With crypto as collateral, it gets really complicated keeping that volatility
in check. Suppose you collateralize with Ether, and
Ether crashes hard enough, then your stablecoin will automatically get liquidated back into
Ether. At that point you’ll be exposed to normal
volatility risks, and Ether may continue to drop. Not only is this risky for users, but
this could be a dealbreaker for exchanges; coz in the case of a market crash, they would
have to deal with stablecoin balances and trading pairs, suddenly mutating back into
another asset. It gets really complicated and hard to fix.
The only way to prevent this, is to over-collateralize to the point where the circulating supply
of stablecoin, is dwarfed by the underlying asset used as collateral, which makes this
the whole setup very capital-intensive. But, MakerDAO is making big moves, so far
this is the most promising stablecoin model. I couldn’t say that stablecoins really are
the holy grail of crypto. But for now, while Bitcoin and Ethereum are still half-asleep,
stablecoins could fill that role for a while. Today, we’ll need a stable currency that’s
able to bypass national currency and border controls. And I think DAI could be one to
fill that role, among other stablecoins. But in 5 to 10 years from now when Bitcoin becomes
the dominant world currency, would stablecoins still be relevant? Hmmm.. I wonder. Damn it feels good to be in crypto!
Thank you so much to all my subscribers. I promise you this channel will become number
1 crypto channel on youtube. Till then, I’ll see you on the flipside.