Learn from Satoshi Nakamoto’s thoughts and regulate cryptocurrency (Part 2)

——About stablecoins

As mentioned above, because stablecoins span cryptocurrency and traditional finance, they have complete currency attributes and can be directly used for cross-border payments and settlements. Bitcoin cannot directly replace fiat currencies, but stablecoins can. Stablecoins have peer-to-peer payment functions and can easily achieve global circulation. They are the second most mature application of cryptocurrency after Bitcoin.

The supervision of Bitcoin, Ethereum, smart contracts, and exchanges is relatively simple because the model is single. However, the wide variety of stablecoins creates regulatory complexity. If stablecoins are not adequately regulated, their risks will be directly transmitted to the traditional financial field. Similarly, the risks of conventional finance can also be sent to the cryptocurrency field through stablecoins. The current risk linkage phenomenon in the stock and crypto markets illustrates this point. The risks of traditional finance will have a more significant impact on the crypto market.

Cryptocurrency is a high-risk market, which means there are many opportunities, giving young people more channels to choose from. If cryptocurrency is just a laboratory model and does not directly affect the modern economy, it will not harm it. However, stablecoins have opened up the connection between the two. Supervising stablecoins is now the top priority of traditional financial supervision. Because the crypto market’s value will increase significantly in the past year or two, and the corresponding crypto stablecoin market is also likely to exceed one trillion U.S. dollars, a slight mistake will be a nuclear explosion-level risk.

Classification and characteristics of stablecoins

Stablecoins can be divided into three main types: stablecoins collateralized by fiat currency, stablecoins collateralized by cryptocurrency, and unsecured stablecoins.

1. Stablecoin collateralized by legal currency

The boss is Tether, which began issuing USDT in 2014 and pegged to the U.S. dollar at 1:1.

This stablecoin is issued centrally. Transparency has no regulatory constraints and relies on the issuance prospectus as a credit certificate. The published data can be found on the Chain Eye website (chaineye.tools/stablecoins/stats/USDT). Its market value is $81.9 billion, while the collateral value is $61 billion. From the data, it can be inferred that there is an over-issuance of 21 billion. There is no 1:1 ratio with the U.S. dollar. However, it is much safer than commercial banks’ 10% reserve requirement.

Commercial banks do not have an operating mode to adjust the fluctuation value of stablecoins. The method used by the Hong Kong Monetary Authority to ensure limited fluctuations in the exchange rate between Hong Kong dollars and U.S. dollars within a controllable range through the purchase and sale of Hong Kong dollars and U.S. dollars is most similar to the stablecoin model. The amount of U.S. dollar reserves held by the Hong Kong Monetary Authority is greater than the amount of Hong Kong dollars actually issued. USDT has no interest, but there is profit in adjusting the fluctuation value of the stablecoin, and the profit should be used as a reserve. The Hong Kong Monetary Authority’s foreign exchange liabilities are 1.2 trillion, and its issuance is HK$600 billion, which is obviously far more than the 1:1 ratio. It is the metric that stablecoins should achieve.

Not having reserves is risky. Tether’s U.S. dollar liabilities are deposited in bonds at Union Bank of the Bahamas. There are dual risks here: bond risk and bank risk. The USDC issued by Circle does not purchase bonds like Tether, nor is it over-issued. It stores U.S. dollars in 8 banks. In the United States, bank bankruptcy only pays 250,000, and it just so happens that this happened. An incident at Silicon Valley Bank in the United States may result in a 3.2 billion impairment of Circle’s U.S. dollar collateral in the bank, which caused significant fluctuations in USDC. However, Tether’s U.S. dollars are only stored in one bank. If there is a problem with the bank, wouldn’t it be wiped out without diversification of investments? For bank risks, it is safe to only deposit fiat currency in the issuing bank, such as depositing U.S. dollars in the Federal Reserve. But how?

What everyone questions about Tether is that it has problems with other investments, which account for about 8%. There should be clear regulations on the business model of such companies and the use of funds. After reading the reports of Tether and Circle, people feel that Circle is more standardized. Still, Circle was involved in the accident this time, which shows that the current regulatory and rescue measures are insufficient.

The model of legal currency stablecoin is simple. A single model is easy to supervise, and program and user exchange can also be programmed, thus reducing the risk of centralization.

The centralized part of the legal currency stablecoin must be supervised. The data after the stablecoin is put on the chain is transparent. However, the data statistics are insufficient, and ordinary users cannot easily check the data. As long as you control the business model of the stablecoin before going on-chain is controlled, the lending model of commercial banks is not allowed to develop, and supervision is relatively simple.

The Hong Kong dollar issued by the Hong Kong Monetary Authority is a stable currency. If it issues a cryptocurrency stablecoin linked to the Hong Kong dollar, it will help form Hong Kong’s encryption center. If it initially targets the crypto market, don’t use the name CBDC. This reputation is terrible in the currency circle.

2. Cryptocurrency-collateralized stablecoins

It is a decentralized on-chain mortgage issuance model, supported by cryptocurrency or multiple assets, using cryptocurrency as over-collateralization. The collateral is usually Bitcoin, Ethereum, and some legal stablecoins. The entire mortgage lending process is algorithmically controlled, automatically creating a stablecoin that is 1:1 convertible to the U.S. dollar. Dai is the leader of this type of project. Since Dai operates on the blockchain and is not an exchange interface between cryptocurrency and legal currency, Dai’s market value is only US$4.8 billion, which is far from the market value of legal stablecoins.

Mortgage-type on-chain stablecoins inherit the transparency and automatic supervision of the blockchain. The long-term operation reliability of the program is very high, and the risk is far less than that of legal currency stablecoins. Apart from team supervision, supervision is almost unnecessary in other aspects.

The problem is that since the block verification time of the blockchain is on the second level, the fastest public chain takes 3 seconds, and Ethereum takes 12 seconds. When the value of mortgaged assets fluctuates rapidly, positions cannot be covered and closed promptly, which is less timely and convenient than centralized exchanges. It is one of the reasons for its slow development. Like distributed exchanges, the idea is good, but their business structures are not suitable for the structure of the blockchain.

3. Uncollateralized Stablecoins

There are also many types of unsecured stablecoins, which rely on algorithms to stabilize them. The underlying supporting assets are often unstable. There is transparency in this type of stablecoin, and it depends on algorithms for automatic management, which aligns with the blockchain’s automatic management principles. Still, the algorithm design has not been successful. The biggest problem is the death spiral. The collapse of Luna (UST) resulted in no market for stablecoins with this type of algorithm. Algorithmic stablecoins are worth studying, and there may be new creations.

After analysis, the current supervision of stablecoins mainly refers to the supervision of legal currency stablecoins, which is a centralized supervision.

The goal of centralized regulation of legal currency stablecoins

The rules and procedures for supervision in the traditional financial field are very mature, and there are many big experts in this field. Just modify the regulations to address the shortcomings of stablecoins and absorb blockchain’s openness, transparency, and automation features.

Legal currency stablecoins are the development direction of legal currency digitization, and CBDC is also a category of stablecoins, with the added control of stablecoins. Compared with CBDC, uncontrolled stablecoins will be more popular in the market. However, the centralized part of the stablecoin must reach the level of openness, transparency, and automation of Bitcoin under regulatory conditions. It is the standard to measure the success of the centralized regulation of legal currency stablecoins.

Web3 is to control one’s assets, and control is the core point of Web3. It is also the key to the future CBDC competition among central banks. This article emphasizes that regulators need to understand Satoshi Nakamoto’s thoughts, formulate regulatory rules and procedures based on tradition, and combine the characteristics of Web3 to keep pace with the times.

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