Stable coins and synthetic crypto bubbles

To the moon! This is what cryptocurrency enthusiasts will tell us about the future prospects of cryptocurrency.

Coin World-Stable Coins and Synthetic Crypto Bubbles

To the moon!

This is what cryptocurrency enthusiasts will tell us about the future prospects of cryptocurrency.

However, as the current situation shows, if some short-term problems caused by stablecoins cannot be solved permanently, cryptocurrencies may indeed become the currency used on the moon.

In fact, as stablecoins take over the crypto economy, a key question that must be answered is “How much liquidity is in the system?”

Although stablecoins may be seen as an “innovation,” they may also pose a threat to the entire crypto ecosystem.

It is marketed as a panacea because they allow anyone to use them even without a bank account, and as an easy way to transact on a global scale.

Stablecoins also make the entire system more fragile because they often rely on private organizations that lack transparency. Their balance sheets currently look more like black holes, and we don’t know what is behind it.

A quick premise is that stablecoins can traditionally be subdivided into off-chain (those that are not directly on the blockchain protocol and supported by fiat currency 1:1) and on-chain (another cryptocurrency as collateral, located in On top of the blockchain protocol).

To facilitate discussion, when the term “stablecoin” is used, it refers to off-chain.

A stablecoin of this type like Tether has become a trick for centralized exchanges to easily transfer liquidity across currencies (and prevent having to deal with bank account closures). However, stablecoins also bring hidden systemic risks, and we, as cryptocurrency investors, have to bear these risks.

In fact, while the stable currency solves the liquidity problem of centralized exchanges, it also externalizes the entire hidden risk to millions of investors in the cryptocurrency field.

If in the short term, stablecoins seem to add value to the system by promoting (or possibly expanding) liquidity, they are also conducive to large-scale speculation and the potential collapse of the entire crypto ecosystem.

In fact, if this paper castle falls, who will bear the responsibility? The answer is simple: millions of retail investors who believe in the potential of cryptocurrencies (because centralized exchanges may rescue whales).

Therefore, if we want to build a solid crypto ecosystem for a long time, we need to clarify some things here.

To do this, we need to eliminate short-term threats.

Solve the problem of liquidity fraud and externalize the risk to the entire system

The core problem of stablecoins is the asymmetry of their underlying systems. On the one hand, they are used as the main medium of transactions by some centralized trading platforms. But on the other hand, we don’t know how much cash and liquid assets they have.

Indeed, the financial system also creates wealth by retaining little liquidity. However, banks that do this (especially after the 2008 financial bubble) must pass the so-called stress test and very strict supervision, and must also disclose their balance sheets.

In contrast, the incredible “financial innovation” of stablecoins allows centralized exchanges to print digital currencies without showing the world how these currencies are supported (some stablecoins are more regulated than others).

In short, they have become black holes, and there is no available liquidity to support them.

This “financial innovation” also went beyond what Wall Street created during the 2008 financial bubble. Financial derivatives with strange names have been repackaged so that they can be off the balance sheet and thus evade supervision.

Paradoxically, Bitcoin was born as a way of contrasting Wall Street, and it has become a modern version of it.

The most interesting features of the crypto-driven world (transparency and openness) have been erased by off-chain stablecoins.

So how do we understand this puzzle?

Let’s take a look at the top three stablecoins currently ranked on cryptocurrency exchanges:

  • USDT
  • USDC
  • BUSD

As we have seen in the case of Tether, this should have been pegged to the U.S. dollar, but it has actually become the most popular way of trading Bitcoin (in fact, most of the Bitcoin transaction volume may come from Tether).

This means that if users want to exchange bitcoins for cash, they may need to use Tether to do so.

Therefore, the user’s Bitcoin is not liquid (exchanged in actual U.S. dollars), so it may be worth zero in the short term (unless the user is willing to hold it indefinitely).

If this is the case, this may have a domino effect on the entire crypto market (although some Bitcoin users have claimed that the collapse of Tether may cause the price of Bitcoin to rise).

What about other stablecoins?

Enter USDC: Coinbase stablecoin

USDC is the stable currency of Coinbase. As explained on the platform:

USDC is a cryptocurrency called a stable currency. Users can always exchange 1USDC for 1 U.S. dollar, giving it a stable price. On Coinbase, eligible customers can earn rewards for every USDC they hold.

What are the key components of this stablecoin? Coinbase explained:

Coin World-Stable Coins and Synthetic Crypto Bubbles

But how do we know that USDC will maintain its value? Coinbase further explained in its FAQ:

Centre, the consortium that mints USDC, holds USD 1.00 for each USDC. These funds are deposited in a special bank account, which is frequently monitored and audited.

In addition, Coinbase also emphasized that the advantage of stable currency is that it does not require a bank account. Therefore, it is borderless, and it is easy to trade with any other token.

Again, although stablecoins do try to solve an important problem of centralized exchanges (the stability of the currency and perhaps liquidity), they undermine the entire purpose of the blockchain-based ecosystem. There is no centralized authority to make them, and everything needs to be open to the community.

On June 22, 2021, the center blog issued a grand statement explaining that the market value of USDC has exceeded 25 billion U.S. dollars.

How do we know what is behind this 25 billion?

Circle and Coinbase publish a report on the Centre website every month. These reports did not tell us any details about their reserves, they were only verified by the accounting services company Kwan Fu CPA (In short, the CPA will look for the consistency of the data and whether it is true, but it will not ” “Assurance” or “Audit”).

It needs to be emphasized that, as a kind of certification, this does not really solve the risk of USDC balance sheet. Instead, it only looks for high-level information.

Such as the size of the USDC issued, and the blacklisted coins. In fact, in the April 2021 report, we found that about 100,000 USDC were blacklisted.

This is what the April reserve account report looks like:

Coin World-Stable Coins and Synthetic Crypto Bubbles

We only know the blacklisted tokens. Due to a request from law enforcement, some keys must be frozen.

There are more and more banned addresses.

Now let’s take a quick look at another key stablecoin: BUSD.

Enter BUSD: Binance stablecoin

Like the Coinbase stablecoin, Binance’s BUSD is advertised as a 1:1 USD backed token and is “highly regulated” (we will see what this means):

Coin World-Stable Coins and Synthetic Crypto Bubbles

It was developed in cooperation with Paxos (the creator of the cryptocurrency exchange ItBit and the stable currency Pax).

On June 30, 2020, at a hearing held by the U.S. Senate Committee on Banking, Housing and Urban Affairs, Paxos CEO and co-founder Charles Cascaria explained:

We believe that stablecoins can solve the systemic problems that exist in the outdated pipelines of our financial system. We must update this architecture to adapt to the world of real-time business activities in the 21st century; we can no longer rely on a system that is only available five days a week, only a few hours, and has a long delay. Due to delays in the settlement of bank transfers, international remittances, and other activities, it may take more than five days for settlement, and consumers and institutions cannot use their funds in a timely manner. This makes it difficult to manage other payments with any predictability. On a large scale of the economy, this will form a complex daisy chain, including loan obligations and unnecessary intermediaries.

He continued:

By design, blockchain-based stablecoins (like those issued by Paxos) allow everyone to use digital wallets and digital dollars equally, just like physical cash. The simplest wallets can be as easy as setting up an email account: apart from applicable regulatory requirements, they do not require a lot of paperwork and have no concept of a minimum balance. Stablecoins can build an ecosystem that supports disadvantaged groups and reduce the impact of differences, such as the onerous fees charged by high-cost checking accounts, overdraft fees, predatory loans, and check cashing and cross-border remittance fees.

Stablecoins are essential to Binance because they are the medium of exchange for transactions on the platform.

It should be emphasized that Binance stablecoin uses Paxos technology to support them. In theory, Binance stablecoin seems to be safer than other stablecoins because its USD deposits are held by FDIC-insured banks.

Here is an interesting overview of “What keeps stablecoins stable?”:

Coin World-Stable Coins and Synthetic Crypto Bubbles

If we go back to BUSD, its certification is reminiscent of Paxos.

The monthly certification report is also called the “reserve account report” and only shows us the balance (the last time it was provided is May 2021):

Coin World-Stable Coins and Synthetic Crypto Bubbles

The same report also explains how to support these reserves:

Coin World-Stable Coins and Synthetic Crypto Bubbles

Therefore, the Paxos standard token (the basis of BUSD) claims that it will strictly maintain a 1:1 peg to the U.S. dollar, and its foreign exchange reserves will also be subject to stricter supervision.

However, it is worth noting that we do not know exactly how many FDIC insurance accounts Paxos has. For each FDIC insurance account, the limit is $250,000. Therefore, in order to cover up the billions of dollars in the market value of BUSD, we can imagine that Paxos will have to keep hundreds (if not thousands) of FDIC insurance accounts?

In addition, in 2020, Coin Metrics discovered that the two most active accounts on Paxos are related to MMM BSC (a well-known Ponzi scheme company).

Therefore, there are also several key issues to be resolved.

What does FDIC insurance mean? What is the level of liquidity? Does the fact that this stablecoin is “more regulated” means that it is also audited more frequently?

As far as we know, we only have monthly proofs, just like other stablecoins, only showing the total available supply of these tokens.

Key points about the issue of off-chain stablecoins

  • Although stablecoins initially tried to solve an important problem, they did represent a potential and interesting evolution of currencies (by making currencies borderless and accessible to anyone), but the way they are structured now also brings systemicity risk.
  • The core risk of stablecoins is their asymmetry in their importance to the entire crypto ecosystem (some central platforms only use stablecoins as a medium of exchange, and stablecoins like Tether may be the main liquidity provider of Bitcoin) and their willingness or How much must be disclosed to the public (So far, we only have a few months of proof telling us the total value of the stablecoins in circulation, but we don’t know how they are broken down).
  • The paradox is that although stablecoins may be the evolution of currencies, they also require strict supervision to function properly and prevent fraud. However, so far, they have only been regulated under certain circumstances. If this is the case, does it make sense to have an off-chain stablecoin in the first place?
  • When we look at the current situation of stablecoins, we can split them based on the collateral they use. For example, stablecoins like USDT are in the “Tether vault”, while USDC is in a decentralized private account. Both are almost self-regulating, and they need to have a high degree of trust in these organizations. Other stablecoins such as Pax and BUSD are collateralized by FDIC-insured banks (how many of these accounts and how many of them are difficult to know).
  • In some cases, stablecoins may lack transparency at all (Tether). In other cases, we may wonder whether these stablecoins can really be redeemed if there is an outflow of liquidity (such as USDC). In other cases, we may want to know how many of them are actually insured (such as Pax and BUSD). Therefore, having clearer, more usable information, more supervision and better auditing of these stablecoins can help us have a more solid crypto ecosystem.

But isn’t it just Bitcoin’s problem?

If Tether is exposed during 2018-2019, this may save the crypto economy from a disaster because its scale is still limited.

However, by the end of 2020 and the beginning of 2021, Tether’s market value has exploded. So far, Tether has taken over the entire ecosystem, trying to suck up a beast worth more than $60 billion. It sounds like an python trying to digest an elephant. Tether also occupies the DeFi space, so this is also a problem for Ethereum.

If these two major cryptocurrencies collapse, guess what will happen to all other cryptocurrencies?

Can we solve it by converting all liquidity into on-chain stablecoins?

On-chain stablecoins like Dai (an encrypted stablecoin built on Ethereum) are very interesting because their philosophy is consistent with an open and transparent system.

This is theoretical. In fact, Dai itself is secured by an off-chain stablecoin.

In short, considering the collateral constituted by USDT and USDC, successful on-chain stablecoins like Dai may not be so secure.

what should we do?

It is difficult to predict what will happen next. Indeed, Bitcoin has survived survival threats time and time again in the past decade. However, paradoxically, at this scale, Tether’s time bomb is indeed likely to kill Bitcoin and send the entire crypto space back to the Ice Age.

Posted by:CoinYuppie,Reprinted with attribution to:
Coinyuppie is an open information publishing platform, all information provided is not related to the views and positions of coinyuppie, and does not constitute any investment and financial advice. Users are expected to carefully screen and prevent risks.

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