Terence Zimwara
The impasse that has prevailed
between crypto entrepreneurs and regulatory authorities meant mass adoption of
crypto-currencies was not going to happen unless a breakthrough was found. To potential
cryptos users, an endorsement of crypto-currency by authorities is seen as an
important step towards instilling more confidence.
On the other hand, regulators
are unwilling to give such an endorsement to any innovation which they see as a
threat, and now with US President Donald Trump accentuating these fears,
endorsement may not come anytime soon.
Prior to Mr Trump’s outbursts against cryptos, central
banks/regulators had for years been adamant that all players in the financial
services industry had to comply with KYC and AML processes without exception.
Central banks genuinely believe they should be able to track
and trace all financial transactions that fall within their jurisdiction;
privacy is not something that overly concerns them. In nutshell, central banks
want to maintain total control.
Obviously creators of
purely decentralized cryptos will never accept this because their innovations
are already popular, in part because they give users complete privacy. Also
anyone who wishes to acquire crypto-currencies is free to do so as long as they
have the funds to make the purchase. There is no documentation required or the usual
KYC procedures, which may be responsible for the exclusion of some 1.7 billion
from the banking system. Crypto-currencies like Bitcoin are permissionless!
This unhealthy
stalemate has subsisted for a few years now although both parties are in
agreement that the Blockchain technology is actually beneficial. Naturally,
this situation has been seen as a call to action for entrepreneurs to create a hybrid
that satisfies the seemingly mutually exclusive needs/concerns of users and regulators.
For the moment, stablecoins appear to be that important
compromise albeit with some limitations. Stablecoins are cryptographic tokens
collateralized with a physical asset, most commonly being fiat money such as the
USD or commodities such as gold or silver. Tokenization of an asset essentially
transfers the ownership and value of an asset to the correlated token. Pure
crypto-currencies may have failed to achieve mainstream adoption thus far due
to the fact they have no ‘intrinsic value’ hence the price volatility.
This tilt from the extreme end of the spectrum—a
decentralized crypto like Bitcoin—to stablecoins indicates an understanding of
challenges stifling pure cryptos. Consequently, there has been a deluge of
generic forms of crypto-currencies, from USDT, a privately issued stablecoin
which is backed by the USD to petro that the Venezuelan government issued coin
and now Libra.
Indeed, pure crypto-currencies were initially created to
compete or replace fiat currency as a medium of exchange and a unit of account.
This has not really happened on a large scale partly due to the aforementioned
reasons and not forgetting the instability of most crypto-currency values, if
not all of them.
As we have seen in preceding articles, many other factors
also contribute to this challenge of slow adoption hence their failure to
upstage fiat money thus far. To illustrate, crypto market capitalization as at
March 11, 2019 was estimated at about $134 billion. At around the same time,
the overall value of banknotes and coins in circulation is over US$7.5
trillion, the global narrow money supply (banknotes and coin, including cheque
account deposits) is US$36.8 trillion, while the global broad money supply
(banknotes and coin, cheque account deposits as well as money market accounts,
savings accounts and time deposits) is more than US$90 trillion, making cryptos
still relatively immaterial compared to fiat currencies. (At the time of
writing, crypto market capitalization had surged to over $300 billion largely
spurred on by Bitcoin, which is set to breach its previous peak.)
As already noted, a number of stablecoins have emerged and
more are coming with the most notable being the upcoming Facebook Libra. The
Libra story supports the growing realization that stablecoins are the future of
cryptos for now and why an alternative system is necessary. Also, the Libra
story could amplify the debate about the importance of Blockchain technology in
bridging the financial services gap.
However, in spite of all this, stablecoins including Libra are
a deviation from the original ethos of digital currencies and thus they cannot pass
as decentralized or permissionless currencies. To understand this point, one
has to observe the structure of the organization behind the Libra stablecoin
for instance. An umbrella body representing the interests of organizations who
are party to this project, the Libra Association Members is being set up.
Purportedly this body will not be under the direct control
of any of the participating organizations but the fact that it is there
underlines the critical difference with Bitcoin which does not have a similar
body.
This is one key deviation from the original principles; pure
cryptos have no central point of failure, there is no big brother snooping
around so to speak. Today politicians and regulators gripe against Bitcoin because
they cannot influence or control those using it or where it is used because it is
decentralized, there is single point to attack.
To illustrate this last point we take the example of the
United States government, which presently relies on the US dollar’s global
dominance to project its power around the world. Washington can literally cut
off any country from the global financial system if it feels that country
threatens its foreign policy objectives for instance. So when the world
switches to a currency, which it cannot control like Bitcoin, the US government
will resist this because such a currency erodes its power.
The much anticipated Libra may not pass the same decentralization
test as Bitcoin because it has a central point of failure, governments can
always exert pressure on either Facebook or the organization charged with
overseeing the Libra project. This is already happening even before Libra is
launched; the US government is essentially asking Facebook to make certain
changes or to slowdown the project and the internet giant will oblige or risk
punitive action.
Indeed most stablecoins are designed in a way that allows
governments and regulatory bodies to have influence in their issuance or
circulation thus setting them apart with pure crypto-currencies.
Stablecoins may be permissionless but there may be
exceptions to this as the Libra case once again shows. Facebook is currently
engaged with US authorities over concerns that Libra might be used as a conduit
for illicit transactions, money laundering and even terrorism funding. The US
government wants be to assured that those it flags as possible money launders
or terrorists, be precluded from using Libra. Facebook may be in position to
give such assurances given its control over the massive user database as well
as the network that will be the key in supporting the stablecoin.
It is quite possible that people in OFAC blacklisted countries
might not be able transact freely with this stablecoin, that is if the US government
has its way. This effectively renders Libra a permissioned stablecoin!
Lastly stablecoins are a deviation from the original
principles of cryptos because they rely on or are backed by fiat currencies
issued by central banks. Backing a crypto with a fiat currency— not matter how
strong—means it will be susceptible to monetary policies and consequences
thereof. Such a coin will be affected by inflation or devaluation of the
underlying currency leaving holders worse off.
As we have observed here, stablecoins are fraught with these
challenges which can potentially render them ineffective. Nevertheless, they
are an important step forward in the quest to have crypto-currencies widely accepted.
In any case, this market needs competition and stablecoins
could prove to be just that competition. There is no doubt issuers of pure
crypto-currencies will be thinking of ways of responding to the upcoming Libra
stablecoin. This means existing pure crypto-currencies will see improvements or
changes that make them more acceptable to potential users thus making the goal of
greater adoption achievable.
Stablecoins are well poised to break the ice and end the
impasse between regulators/governments and the Blockchain movement. Most important,
stablecoins could be the final piece needed to bring financial services to
those who do not have them. The next few years will be important for this small
but critical industry.
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