Tether, off-chain stablecoins and synthetic crypto bubbles

This is what crypto enthusiasts will tell you about the future prospects of cryptocurrencies.

However, as the current situation shows, if some short-term problems caused by stablecoins are not solved well, cryptocurrencies may really be the currency used on the moon.

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

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

They are sold on the market as panacea that can help solve all problems because they allow anyone to use them even without a bank account, and as a simple way to trade on a global scale.

Stablecoins also make the entire system more fragile because they usually rely on private organizations that lack transparency, and their balance sheets currently look more like black holes, and we are not sure what is hidden behind them.

As a quick premise, stablecoins can traditionally be subdivided into off-chain (those that are not directly on the blockchain protocol and supported by fiat currencies at a 1:1 ratio) and on-chain (another cryptocurrency as collateral, And on top of the blockchain protocol).

For the sake of discussion, when using the term “stable currency”, I mean off-chain.

As I explained in my article on Tether, this type of stablecoin becomes a trick for centralized exchanges to easily transfer liquidity between different currencies (and prevent having to deal with bank account closures). However, stablecoins also bring hidden systemic risks, and we, as cryptocurrency investors, are all taking 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 add value to the system by promoting (or possibly expanding) liquidity, then they are also conducive to large-scale speculation and the potential collapse of the entire crypto ecosystem.

In fact, if these paper castles all collapse, who will bear the consequences? The answer is simple: millions of retail investors who believe in the potential of cryptocurrencies (because these giant whales may be rescued by centralized exchanges).

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

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

Resolve false liquidity and externalize risks to the entire system

The core problem of stablecoins is the asymmetry of the underlying system. On the one hand, they are used as the main trading medium 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 not only disclose their balance sheets, but also undergo so-called stress tests and very strict supervision.

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

In short, they become like black holes, without any available liquidity to support them.

This “financial innovation” also went beyond what Wall Street created during the 2008 financial bubble. Financial derivatives with peculiar names are repackaged in order to be stripped from the balance sheet, thereby evading supervision.

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

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

So how do we understand this puzzle?

Let’s take a look at the top three stablecoins in the current cryptocurrency exchanges:

  • USDT(Tether)
  • USDC (or USD Coin)
  • BUSD 或 或 Binance USD)

Tether has been extensively covered here (I will add some key points at the end).

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

This means that if you want to convert Bitcoin back to cash, you will most likely need to do it through Tether. If so, there may be no evidence of attitude to support this view.

Therefore, your Bitcoin has no liquidity (it can be exchanged for actual U.S. dollars), so its value may be zero in the short term (unless you are willing to hold it indefinitely).

If so, this may translate into a domino effect on the entire cryptocurrency market (although some Bitocoiners claim that the collapse of Tether may cause the price of Bitcoin to rise, this does not make much sense to me).

What about other stable coins?

Enter USDC: Coinbase stablecoin

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

USD Coin (USDC) is a cryptocurrency called stable currency. You can always exchange for 1 USD token at a price of 1.00 USD to stabilize its price. On Coinbase, eligible customers can get rewards based on every dollar token they hold.

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

Tether, off-chain stablecoins 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 constantly monitored and audited.

Also in this section, Coinbase emphasized that the advantage of a 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.

Once again, although stablecoins do try to solve an important problem of centralized exchanges (the stability of the currency and the possible solution of liquidity), they undermine the overall goal of the blockchain-based ecosystem. Where there is no central institution to cast them, and where everything needs to be visible and open to the community.

On June 22, 2021, a magnificent announcement was issued at the Centre, explaining that the market value of USDC has exceeded 25 billion U.S. dollars.

How do we know what is hidden behind this $25 billion?

Circle and Coinbase publish a report on the Centre website every month. These reports did not tell us any information about the details of their reserves, they were only confirmed by the accounting firm Grant Thornton LLP (in short, the accounting firm looks for the consistency of the data, if this is true, but it is not a guarantee “Or “audit”).

It should 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.

For example, the size of the USDC issued, and the tokens that have been blacklisted. In fact, in the April 2021 report, we found information about 100,000 USDC being blacklisted.

This is what the April Reserve Account report looks like:

Tether, off-chain stablecoins and synthetic crypto bubbles

We only know the blacklisted tokens, because some keys must be frozen because of a request made by law enforcement agencies.

There are also more and more prohibited addresses, you can track them here.
Now let’s take a quick look at another key stablecoin: BUSD.

Enter BUSD: Binance stablecoin

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

Tether, off-chain stablecoins and synthetic crypto bubbles

It was developed in collaboration with Paxos (the creator of the cryptocurrency exchange ItBit and the stablecoin 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 Cascarilla explained with the theme of “Digitalization of Currency and Payments”:

We believe that stablecoins can solve the systemic problems in our financial system’s outdated pipelines. We must update this architecture for the 21st century world, where business happens in real time; 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 wire transfers and other activities, it may take more than five days to settle, so consumers and institutions cannot obtain their own funds in a timely manner. This makes it difficult to manage other payments with any predictability. In the economic context, this will form a complex Daisy chain, including loan obligations and unnecessary intermediaries.

He continued:

By design, blockchain-based stablecoins (such as 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 different impacts, 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 vital to Binance because they act as a 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 dollar deposits are held by FDIC-insured banks.

Here is an interesting table from the overview of “What makes stablecoins stable?”:

Tether, off-chain stablecoins and synthetic crypto bubbles

If we go back to Binance Dollar, its proof 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 was May 2021):

Tether, off-chain stablecoins and synthetic crypto bubbles

The same report also explains how these reserves may be supported:

Tether, off-chain stablecoins and synthetic crypto bubbles

Therefore, Paxos Standard Token (the basis of Binance USD) is said to maintain a strict 1:1 peg to the U.S. dollar, and its reserves are subject to more 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 must keep hundreds or even thousands of FDIC insurance accounts?

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

Therefore, there are still some 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 what went wrong with the off-chain stablecoin

  • Although stablecoins initially tried to solve an important problem, and they do represent a potentially interesting currency evolution (by making them borderless and accessible to anyone), the way they are structured now also brings the system Sexual risk.
  • The core risk of stablecoins is their asymmetry in their importance to the entire crypto ecosystem (some centralized platforms only use stablecoins as a medium of exchange, and stablecoins like Tether may be the main liquidity provider of Bitcoin) and their willingness The degree of asymmetric or must be disclosed to the public (so far, we have only a few months to prove that we can tell 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 work properly and prevent fraud. However, as of now, 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 landscape of stablecoins, we can break them down according to the collateral they use for reserves. For example, stablecoins like USDT (Tether) are in the “Tether Vault”, while USDC (Coinbase stablecoin) is in a decentralized private account. Both are almost self-regulating, and they require a high degree of trust in these organizations. Other stablecoins such as Pax (from Paxos) and BUSD (Binance stablecoin) 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 want to know if liquidity escape (such as USDC) is possible, whether these stablecoins can really be redeemed. In other cases, we may want to know how many of them are actually insured (such as Pax and BUSD). Therefore, having clearer, available information, more supervision and better auditing of these stablecoins can help us have a more stable crypto ecosystem.

But isn’t this just a Bitcoin problem?

If Tether is exposed between 2018 and 2019, this may save the crypto economy from 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, and the beast trying to deplete more than $60 billion sounds like an python trying to digest an elephant. As highlighted in this tweet, Tether has also taken over the DeFi field, so this is also an Ethereum issue.

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

Can it be solved 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.

In theory, this is the case. In fact, as stated here, Dai itself is secured by off-chain stablecoins.

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

What can 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 field back to the Ice Age.

Therefore, for all users in the cryptocurrency field, it is time to quickly repair the system from Tether and start immediately.


Posted by:CoinYuppie,Reprinted with attribution to:https://coinyuppie.com/tether-off-chain-stablecoins-and-synthetic-crypto-bubbles/
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.

Like (0)
Donate Buy me a coffee Buy me a coffee
Previous 2021-08-09 09:05
Next 2021-08-09 09:07

Related articles