Can government be blamed for creating stablecoins?

18 July, 2019

Do not ask a diehard cryptocurrency purist about stablecoins unless you are prepared for a long and detailed dissertation as to why such digital assets really are not genuine cryptos. Needless to say there is not a whole lot of love lost between those who love stablecoins and those who wish they would be forever purged from the crypto community.

It is with that understanding that we approach a topic raised recently among U.S. legislators trying to decide what, if anything, they are going to do about Facebook's Libra stablecoin. The issue was raised at hearings being held by the U.S. Senate Banking Committee by a 22-year Wall Street veteran who also happens to be the co-founder of the Wyoming Blockchain Coalition.

Caitlin Long asserted in written testimony that government regulations have been the primary driving force in the creation of stablecoins. According to her testimony, investors would trade in and out of digital assets using U.S. dollars if the law would allow them to do so. But since they cannot, stablecoins are the only other alternative.

Her argument does make sense to some degree. However, what's puzzling is the fact that investors actually can buy digital assets with U.S. dollars. Perhaps what she meant to say was that government regulations have made doing so more difficult than it needs to be. At any rate, the question still remains: can government be blamed for creating stablecoins?

Characteristics of a stablecoin

Digging deeply into Long's argument requires getting a handle on what a stablecoin actually is. A stablecoin is a digital currency not completely unlike Bitcoin, Litecoin, etc. It exists as the result of the creation of a distributed ledger and the issuance of digital tokens via that ledger. And in theory, a stablecoin is just as decentralized as a more traditional cryptocurrency. Yet there are distinct differences.

First and foremost, a stablecoin is linked to some other recognized asset as a means of determining its value. Most stablecoins are linked to fiat currencies, like the U.S. dollar. Tether and USD Coin are two examples. The price of both coins is directly in line with the dollar. One USD Coin is worth one U.S. dollar. It is that simple.

Stablecoins do not have to be linked to fiat, though. Some are linked to commodities like gold and silver. Others are linked to securities (bonds, government notes, etc.), and still other times they are linked to other digital assets with proven value.

The next difference is that stablecoins are generally collateralized. That means they are actually backed by the asset they are linked to. This is accomplished by the custodian of said digital asset holding an equivalent amount of the linked asset. A custodian holding $500,000 in USD Coin would also be holding $500,000 in cash.

Collateralization is what gives a stablecoins their stability. It removes most of the risk of volatility, making them more attractive to organizations that want to use digital coins without worrying they are going to lose their shirts.

Finally, stablecoins can be issued by any individual or organization who wishes to do so. This is no different than traditional cryptocurrency platforms. Anyone with the right coding skills and a bit of hardware can create a stablecoin with very little effort. Then it is simply a matter of raising the funds necessary to get the coin off the ground.

The birth of the stablecoin

Tether (USDT) is regarded as the first viable stablecoin to hit the market. Work on the coin actually began back in 2012, among a group of tech experts who believed it was possible to create a 'second layer' of cryptocurrency that was not as volatile as Bitcoin and its alt coin competitors. The first asset released by the project was known as Realcoin. The Tether token followed just five months later.

Tether was birthed out of a desire to give commercial enterprises access to digital assets without the volatility. The thinking here was that digital assets could be quite functional for commercial applications if only organizations didn't have to worry about losing a ton of money. Thus the original creators of Tether came up with the idea of collateralization. They guaranteed the value of their coins by backing them with U.S. dollars.

It wasn't long before a small handful of exchanges began trading Tether. Meanwhile, the Tether organization made it possible for traders to link their tokens to Japanese yen or euros, instead of the U.S. dollar, if they wanted to.

Although Tether has been the subject of quite a bit of scrutiny and criticism over the years, the project has proved the viability of stablecoins in principle. Thus JPMorgan announced a few years ago that they would be launching their own stablecoin. And of course, Facebook's Libra is a stablecoin as well.

Stablecoins and government regulation

All of this leads us back to Long's central argument that government regulation is responsible for the creation of stablecoins. As we previously stated however, investors can trade in and out of cryptocurrencies with U.S. dollars. If you want to spend $1 million to buy Bitcoin, you can do so. Then you can sell your coins tomorrow. So what was Long really driving at?

The answer to that question lies in the JPMorgan stablecoin, a.k.a. JPM Coin (JPM). JPMorgan does not intend JPM to be either a general-purpose digital asset or a commercial investment. The goal is to make the coin a completely utilitarian tool for improving bond and securities transactions.

Consider that JPMorgan is one of the largest financial institutions in the world. They transact billions of dollars in business every year. All of those transactions must be processed through the traditional banking sector which, as you know, is heavily encumbered by regulation. Long's argument seems to stipulate that those regulations are the impetus behind JPM - whether directly or indirectly.

JPMorgan can release its tokens by offering them to any clients whose transactions they process. Even organizations whose business is not directly related to JPMorgan could benefit through faster and more efficient transactions. So they might buy into the project as well.

With tokens in hand, organizations can trade among one another without having to go through traditional banking channels. JPMorgan's stablecoin platform allows for fast, secure, and efficient transactions that happen as quickly as possible and without bureaucratic red tape.

So far, the idea of government regulation being responsible for stablecoin creation seems right in the mark. But we are not done yet. There are a couple of additional things to look at.

If regulations were different

Long's argument seems to suggest that stablecoins would not be necessary if government regulations were different. In other words, government regulations as they currently stand hinder efficiency in the financial sector. Get rid of those regulations and you get rid of the inefficiencies as well. But since government is unwilling to do that, the financial sector has apparently taken the matter into its own hands.

The argument is a strong one, at least in some aspects. Start with the understanding that no one is ever going to get rich off a stablecoin. Because stablecoins are collateralized and linked to a specific backing asset, their value will rise and fall in relation to that asset. Getting rich on stablecoins would be at least as difficult as getting rich in Forex trading, if not more so.

That means the real value in stablecoins rests in their utility. In this respect, Long is absolutely correct that organizations are looking to utilize stablecoins to do what the traditional financial sector cannot do. Yet that still does not mean government regulation is the root cause that led to the creation of stablecoins to begin with.

In the case of Facebook's Libra, government regulation really has nothing to do with it. Facebook sees opportunity to monetize a stablecoin by tying it to all of its current and future applications. Facebook hopes to leverage its global user base as a way to encourage trading with Libra on a global scale. And at the end of the day, they only have one goal: profit.

It seems highly unlikely that Facebook executives were sitting around looking for a way to help impoverished countries in spite of government financial regulations. Even though Facebook is framing the Libra as a tool for social justice, it is still all about money. They just happen to think that the popularity of cryptocurrency is something they can exploit. And they only chose the stablecoin route because they cannot allow any volatility to interrupt their plans. A stablecoin gives them the platform to launch themselves into financial services without having to be a bank.

In the end, stablecoins do have some characteristics that make them very attractive to financial institutions and global corporations bogged down by regulation. That much cannot be argued. But to say that stablecoins would not exist if it were not for cumbersome regulations is a bit of a stretch. Stablecoins exist because cryptocurrency volatility exists. Find a way to control volatility and you eliminate the need for the stablecoin.