Crypto Research

Crypto Comics – What is Stablecoin

I shared my thoughts about Stablecoin.

TL;DR

I shared what stablecoin is and how to use it in the crypto space.

Some Takeaway

The idea of stablecoin is not new at all! In fact, everyone was doing it until they realized they were actually doing it. In the crypto space, stablecoin experienced the roller coaster from the most stupid idea ever to the most genius idea ever! How come all of a sudden people changed their minds so fast and so extreme? Thanks to the Fed’s enormous economical power to demonstrate that one could print so much money that they wanted to accomplish so little.  

Money Supply

I will not go deeper into the math here but simply demonstrate the concept. What you got here is how much the nation is totally worth to divide how much money will circulate in the nation to produce a factor called the velocity of the money. The higher the velocity, it means you got a low supply of money with a high worth of the nation. Then the economy is doing very well and people spend money to buy anything they want. When the velocity of money becomes low, that means you have too much money in circulation while the nation does not value that much. Then likely you will cut the supply of money or make the nation more worthy.

This is a core idea of stablecoin. The goal of stablecoin is to make the velocity of the money stays at 1.

How Country Manipulate Money Supply 

What if I told you the dollar bill is a sort of stablecoin apart from gold? The central bank is an agent to adjust the money supply to indirectly influence the economy and the value of the stablecoin. There are many ways to manipulate the money supply in a closed-door fashion but the goal is the same, to increase or decrease the total money circulation in the nation so that the dollar bill stays at 1.

Unlike the stablecoin that can reduce the money supply, the nation cannot destroy the amount of money they issued, but instead, they adjust interest rates. The higher the interest rate, it reduces the money supply because it will slow the growth of the economy. The lower the interest rate, it increases the money supply and boosts economic growth.       

2014    

Image credit: https://www.coolwallet.io/the-complete-guide-to-stablecoins-part-i-2014-2019/

After the success of Bitcoin, the crypto community was struggling to separate from Bitcoin and tried something new. After the movement of the colored coin in 2012, cryptocurrencies tried to become more utility tokens. The idea of stablecoin was introduced. There were many unknown attempted coins introduced earlier but many were failed.     

A Stupid Idea

The stablecoin idea was a stupid idea back then. Nobody liked the idea to stabilize the price fluctuation and the whole point of cryptocurrency was too unstable and large a fluctuation to gain price momentum. And who would hold a stablecoin if one did not believe in the dollar system anymore?  

BitUSD

BitUSD was the first stablecoin ever created in 2014. But it did not survive long because it tried to mimic a difficult manipulation from the central bank. There was not enough collateral to back the stablecoin which eventually made the coin default.  

Flaw Assumption of the Stablecoin

Even though stablecoin made a statement about their pegging 1 to 1 ratio, they hardly can keep their promise. Unless you would have the exact amount of worth of assets against the supply of the stablecoin, you would likely be a default.  

Remember the velocity of the money, instead of the nation worth you replace it with the market capitalization. You got your simple formula of stablecoin. Only the problem is what is your market capitalization? Unless you use all cash or cash equivalents against the market capitalization, you are guessing your stablecoin value to stay at 1. That is the problem for BitUSD to default. They assumed their coin was at 1 but it is roughly around 0.7 for more than 2 months. 

Tricks

Instead of having so much money to peg, others make a risky decision to gain from the secondary market through arbitrage. The simple concept of arbitrage is to take advantage of mispricing from the different exchange rates and make a profit out of them. A common practice (manipulation) in the stock market is. When investors trade in the secondary market, the stablecoin treasury is also trading with investors to explore opportunities for arbitrage. That way, even if you think you pay $1, you may pay more than it is supposed to be worth and in the meantime stablecoin treasury gains from your transaction. 

Code

Image credit: https://levelup.gitconnected.com/creating-a-non-collateralized-stablecoin-82fb1258647e

Thanks to EIP-721, the stablecoin can be executed through automation on their supply followed by EIP-721. You cannot directly reduce the money supply in the central bank but you can do so in the stablecoin through a burn function. You increase the supply of the stablecoin through the mint function and reduce it through the burn function. Now you have the ability to control the coin supply.

Guessing Game

Different types of stablecoin will have different ways to guess the market capitalization. The more unstable assets you try to peg, the more unstable your stablecoin will be. Fiat-backed stablecoin is the most feasible way in this case.

Profit Model

One may question how stablecoin makes profits? The answer is through arbitrage and gaining more treasury. I explained arbitrage previously. The interest rate is higher than stablecoin is higher than fiat because they want your money ASAP. The more money they have, the more likely they can issue more stablecoin and have more opportunities to arbitrage around the exchange.

A Genius Invention

After the 2020 COVID impact on the global economic recession, stablecoin became a focal point of future finance. It is a private treasury with the equivalent of power to the central bank. It is an invention to challenge the current central bank and possibly to provide innovation to change the financial system in the future.

In conclusion

Stablecoin is unstable. However, it gives a possible way to have a stable innovation of the future. 

Check out my other article

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