Summary: Benjamin Gu: In my Libra project analysis report (A Business Analysis of the Libra Project), I pointed out that there is still a very good opportunity to develop a new stablecoin that competes with Libra. The Libra project is definitely not the end of the stablecoin project, but a milestone in this process. More stablecoin ...
In my Libra project analysis report (A Business Analysis of the Libra Project), I pointed out that there is still a very good opportunity to develop a new stablecoin that competes with Libra. The Libra project is definitely not the end of the stablecoin project, but a milestone in this process. More stablecoin projects will appear to provide more stablecoin products for the market. In terms of the mechanism for generating stablecoins, other stablecoin products can be substantially different from Libra. In terms of application scenarios of stablecoin, a more suitable application scenario can also be adopted. In view of the fact that stablecoin is still at a very early stage and all the risks of the Libra project, other stablecoin products still have a very high probability of success. As long as the correct strategy is adopted in the design of stablecoin, promotion organization and adoption scenario, it is very likely that the new stablecoin can be better accepted by the market. This article discusses some of the factors related to the new stablecoin.
The first thing that should be made clear is that a stablecoin project should not be a stand-alone infrastructure stablecoin project. In other words, one should not start a project just to make a stablecoin. Because of the currency nature of stablecoin, it cannot be hoped to make a profit from the stablecoin itself. Stablecoin should be used as a tool to support other businesses. Only when such a business develops can the stablecoin develop simultaneously. This is just like the development of Alipay with the development of online shopping. The development process of stablecoin should also be the same. Such a mechanism is also the motivation for Facebook to develop stablecoin.
Facebook’s purpose in developing a stablecoin was not just to launch a stable digital currency that can be used worldwide. Although the purpose of the project, according to the whitepaper, is to provide financial services to 1.7 billion people without financial services worldwide, Facebook’s goal is to help Facebook provide financial services to its users, so it can achieve business growth. This is the true purpose of Facebook to develop this product. The actual goal of this stablecoin project is to be used by Facebook’s main business, not just to develop a stablecoin itself. But such a business logic does not seem to be seen by all the stablecoin providers. For service providers who only offer a stablecoin solution and no other main business, the profitability challenge will be enormous.
1. Two forms of future stablecoins
Future stablecoins will exist in two forms (See my article in Chinese, Predicting the Development Trend of Stablecoin Based on Money Theories). One is a digital version of the fiat currency issued by each central bank. The essence of this digital stablecoin is credit currency. The other is a stablecoin that is minted in a distributed manner and based on collateralized digital assets. The essence of this stablecoin is commodity currency. This mechanism follows the tradition of Bitcoin. It relies on technology and market to guarantee the generation and circulation of this stablecoin.
Various stablecoins currently in the market are issued on collateralized fiat currencies and are pegged to one single fiat currency. The only difference between them is whether it accepts a single fiat currency or several fiat currencies. Such a stablecoin is actually a derivative of fiat currencies, and it is in essence a credit currency. The attributes of such a digital stablecoin still dependent upon the attributes of the fiat currency that it is pegged to. In my opinion, such stablecoin is only a transitional state of the stablecoin product. After central banks issue their own digital fiat currencies, such stablecoin will be phased out in the market. Stablecoin that is developed in a distributed manner and based on collateralized digital assets will be accepted in the market for a long time.
2. Digital asset exchange is the foundation of the new stablecoin
With the development of blockchains and encrypted digital assets, it has been found that smart contracts can be used to represent various rights and assets. Digital assets represented by smart contracts on the blockchain not only have richer attributes, but also embedded business rules. Most importantly, the digital assets represented by smart contracts can be traded directly between accounts on a blockchain.
The process of using smart contracts to represent assets has already started. The state of Delaware, USA, has legally recognized company shares registered on the blockchain. Some types of alternative assets such as real estate and private equity funds are being represented as security tokens. Such security tokens are used to raise money and being circulated in the secondary market.
Due to the limits of current US securities regulation, users that can invest in and trade such assets are very limited. However, there are now two companies that are applying to SEC to set up digital security exchanges. Such digital security exchanges will provide trading services to these security securities. In Switzerland, the Swiss Stock Exchange has established the Swiss Digital Exchange SDX. The Swiss Stock Exchange expects that the products traded in SDX will supersede those traded on the Swiss Stock Exchange in the next decade.
Future digital assets will be traded in exchange to obtain fair pricing. The exchange will be global in nature and will be more transparent. The operation mechanism of the exchange will be a mode of centralized trading and distributed clearing. This will provide a solid foundation for issuing stablecoin based on digital assets.
Digital assets listed and traded on the exchange provide the asset base for a commodity-based stablecoin. In the history of currency development, the currency before fiat currency was commodity currency. The basis of such commodity currencies are usually gold and silver. It was later that government’s credit was used as the foundation of currencies. A major problem with credit-based currencies is government’s unrestricted ability to issue money. This situation has existed since the emergence of fiat currency. It has appeared in the history of China and other parts of the world. And it still continues to happen. Money oversupply inevitably leads to financial and economic crises. This is the inherent flaw of fiat currency itself. Of course, we shouldn’t deny the value of fiat currency because of this. Fiat currency has played an important role in the development of the modern economy. But, in today’s society, with the development of the internet and blockchain technology, there is now an opportunity to produce a new type of money that is minted with lower cost and can be used worldwide in a more efficient way. Such a stablecoin can avoid the destructive effects of some sovereign countries’misguided monetary policies.
In the future, digital currencies based on sovereign government credit and digital stable money based on digital assets will coexist and compete in the market. This will force each currency to maintain its quality. The stable development of global economy therefore can be better guaranteed.
2.1. Exchange provides asset base for stablecoin
In the current US securities market, security token is being used to digitize assets and is being traded in the secondary market.
Although the types of assets currently developed in this way are only part of alternative assets and are only a small number of all asset types, the benefits that this approach can achieve are already significant. These alternative assets such as real estate and private equity funds are now being customized into much smaller and standardized units, and these units can be traded on a more efficient and low-cost network. Both liquidity and premium have been significantly improved. This mechanism for asset digitization can also be applied to mainstream asset types such as company equity. Such an application will not only increase the liquidity and premium of mainstream assets, but also significantly increase the overall efficiency of the capital market (see my article in Chinese, The Twilight of Nasdaqs). In fact, the current global capital market has formed a consensus on this. The Swiss Digital Asset Exchange is the leading practitioner in this area. There are also two companies in the United States that are applying to the SEC to establish such digital securities exchanges. The two companies are the Miami International Holdings (MIH) and Templum’s joint venture and the BOX exchange with tZERO’s joint venture, respectively.
2.2. Exchange provides application scenarios for stablecoin
Digitization of asset and currency is a trend. But where does this trend start? The application of digital currency must begin at where existing currencies do not serve well. Such areas include regions where sovereign currencies lose their credibility such as current Venezuela, or regions where sovereign currencies are not used conveniently such as cross-border transactions and transfers. In various cross-border transactions, digital assets trading on a global scale is inconvenient using fiat currencies. In fact, the earliest stablecoin Tether was created to facilitate the trading of digital assets for users around the world. The main application scenarios for some stablecoins that have emerged since then are also in the field of digital asset trading. Most importantly, digital asset trading is growing worldwide. It has shown a strong growth trend. This growth will certainly drive the growth of stablecoins. This is like the rapid growth of online shopping led to an urgent need for a mechanism to ensure the completion of transactions. This led to the emergence of Alipay. Alipay has grown with the growth of online shopping. It later developed into an independent payment instrument and clearing network.
2.3. The technical basis of the exchange
Such a digital asset exchange must be a combination of centralized trading and distributed clearing. Users manage their digital assets on the underlying chain or have them stored by third-party custodian companies on the same chain. When the user conducts a transaction, the centralized matching mechanism performs the transaction matching, and the matched order is directly cleared and settled between accounts. The two-tiered clearing arrangement in the current securities market is therefore not needed. The efficiency of the transaction will be higher, the cost will be lower, the market risk of the client’s funds will be smaller, and the utilization of funds will be higher.
2.4. The organizational model of the exchange
The development of blockchain technology has led to innovation in more fields. One of them is innovation in organizational form. Bookkeeping on the blockchain is passed through the consensus of all nodes before it can be recorded on the chain. Such bookkeeping methods have spurred the development of membership-type organizational form. In the development of Ethereum, it tried to decide on the development of the blockchain based on the voting of the Ethereum community by means of DAO (Distributed Autonomous Organization). Although The DAO organization did not go well, it has inspired more attempts in this area since then. CENTER which is jointly supported by Coinbase and Circle (See my article in Chinese, Why Does Circle and Coinbase Jointly Supported USDC Can Develop into a Real Stablecoin?), Fnality which is supported by UBS and other financial institutions (See my article in Chinese, Fnality, a Milestone in the Evolution of Financial Market Infrastructure), and the Libra association can be said to be the inheritance and development of this organization type.
Of course, membership-based companies have long existed. For example, credit cooperatives in the financial industry and the Option Clearing Corporation that I used to work for are such organizations. However, such an organizational form is usually confined within a small geographical area or an industry within one legal jurisdiction. Such organizations cannot expand globally. The emergence of blockchain technology provides a solid foundation for supporting the expansion of this organizational form on a global scale. Organization rules can be programmed into smart contracts and run automatically. The fairness of this organization can therefore be guaranteed. Any company anywhere in the world that meets the requirements of such an association can join and has the assurance that the fairness of this organization can be guaranteed. The Libra Association can be said to be a recent attempt in this regard. Its current governance mechanism is still the traditional way, but I believe that it will gradually program more governance rules into smart contracts.
In the securities industry, I believe that future digital asset exchange must be a digital asset exchange (See my article in Chinese, The Next Blockchain-based Cross-border Financial Alliance) formed by a consortium of securities firms around the world. Its organizational form will also be a governance mechanism supported by blockchain technology. The goal of such an exchange is to attract more security firms to participate and make this ecosystem bigger on a global scale. Fair and reasonable business rules based on blockchain technology support are the basis for attracting brokers from all over the world. With the participation of security and investment firms around the world, assets worldwide can be listed and traded on this exchange, which will provide sufficient underlying assets for issuing stablecoins.
3. New stablecoin mechanism
3.1. Value base
In the scenario of this exchange, the value of the new stablecoin is based on the digital assets traded on the exchange. Since the exchange’s trading is 7 x 24 hours worldwide, the valuation of these digital assets is therefore a fair one. The value base of the stablecoin issued this way is therefore a consensus result of the market.
In the current banking and securities industry, collateral management is a day-to-day business. The asset owner uses its own assets as collateral to borrow some funds from other parties. When the owner finishes using the fund, it will return the fund plus some interests to redeem the assets that have been collateralized. In stock exchange market, one type of asset that is often used as collateral is security. High quality security and good liquidity make them ideal for lending as collateral. In the context of digital asset trading, some high-quality digital assets can also be used to generate stablecoins. At present, there is a distributed mode represented by MakerDAO which accepts digital assets on Ethereum as collaterals. As technology evolves, more types of digital assets can be used to mint stablecoins in the same way. Even for digital assets that cannot be coined in this way, in this exchange scenario, coinage can be done in a centralized collateral and custody manner. Therefore, the asset base of the stablecoin is even greater. More stablecoins therefore can be minted this way.
Libra is based on fiat currencies and short-term government bond collateral. This model of issuing stablecoin based on asset collateral is commonly used in the market today. Prior to Libra, digital stablecoins such as USDC were generated based on US dollar collaterals. So Libra is an improvement in using collateral assets to issue stablecoins. The new stablecoin proposed in this paper is based on actual assets listed and traded on the exchange, so the value base of the new stablecoin is a further improvement over the Libra stablecoin.
3.2. The price of the stablecoin
The Libra stablecoin price is pegged to a basket of fiat currencies. Price of stablecoins before Libra is pegged to US dollar. Therefore Libra’s price is more stable. The new stablecoin proposed in this paper will be pegged to a basket of fiat currencies for a long time in the future. Such a mechanism is a viable one. The difference between the new stablecoin and Libra is fiat currencies in the basket and their respective weights.
3.3. Monetary policy
Libra clearly states in its whitepaper that it does not have its own independent monetary policy. Libra’s monetary policy is entirely dependent upon the monetary policies of fiat currencies in the basket it is pegged to. Similarly, for a long time in the future, the new stablecoin will not have its own independent monetary policy. It will also depend entirely on the monetary policies of fiat currencies in the basket. In this respect, Libra has improved compared to the previous stablecoins, because the monetary policy of previous stablecoins is completely dependent on US dollar. The fluctuation of Libra stablecoin due to changes in monetary policy is therefore much smaller.
3.4. Number of stablecoins issued
The amount of Libra’s circulation in the market is entirely dependent on the needs of the market. This quantity mechanism is same as previous dollar-based stablecoins. The new stablecoin is no exception in this respect. This stablecoin is actually a derivative of existing fiat currencies, so the amount of circulation in the market should also depend entirely on the amount of circulation of fiat currencies in the basket.
3.5. Coinage tax
Libra’s direct coinage income is the interests proceeds from collateralized fiat currencies and short-term government bonds. Income obtained this way is not high and may even be negative. The coinage tax of Libra’s previous stablecoins is also generated from interests of collateralized US dollars. The new stablecoin is able to obtain a slightly higher income for seigniorage tax because it is issued and circulated in the exchange environment. The exchange can support the coinage business in the form of collective lending. In other words, the exchange provides a stablecoin-based financing service. Traders can borrow stablecoins from the exchange for their own leveraged trading. The exchange derives revenue from this business and allocates a portion of the proceeds as a coinage tax to participants.
4. Comparison of new stablecoin and Libra stablecoin
The table below shows a comparison of the new stablecoin with the Libra stabilized currency.
|Libra Stablecoin||New Stablecoin|
|Value Base||Fiat currencies||Digital assets|
|Nature of Currency||Credit||Commodity|
|Quantities issued||Determined by market||Determined by market|
|Seigniorage||Interests from collateralized fiat currencies||Market premium from trading|
|Promoting organization||Libra Association||Digital asset exchange|
|Early adopters||The unbanked and underbanked worldwide||Digital asset traders worldwide|
|Early application scenario||All financial services||Digital asset trading|
4.1. Different value bases
The fundamental difference between the new stablecoin and the Libra stablecoin is the value base. The Libra stablecoin is still essentially a credit currency. The value of the new stablecoin is based on digital assets, so it is in essence a commodity currency. Both currencies have their own characteristics. The coexistence and competition between the two in the market will bring better choices for the market in terms of currency.
4.2. The initial focus of the underlying blockchain is different
Libra’s underlying blockchain is developed for circulation of Libra stablecoin. But it also supports the application of smart contracts. Therefore, more complex financial products such as stocks can be circulated in this blockchain. The underlying blockchain of the new stablecoin must first support the clearing and settlement of digital assets. It therefore needs to support digital currency and more complex financial products from the very beginning.
4.3. Different initial application scenarios
The goal of Libra is to provide a financial infrastructure on a global scale to serve the world’s 1.7 billion unbanked and underbanked population. This is indeed a viable business strategy to promote stable coins. I analyzed this in a previous article (See my article in Chinese, How to Use Blockchain to Bring Paradigm Shift to the Global Personal Loan Industry?). This area is currently an area that mainstream financial institutions do not serve well. The emergence of blockchains and stablecoin now provides an opportunity to make improvement in this area. Facebook can use its social network to provide stablecoin-based financial services to its users worldwide. The initial application scenario for the new stablecoin is digital asset trading. Such an application scenario is in line with the actual needs in the market and is an area of strong growth. Therefore, the new stablecoin will gradually be adopted in the market.
4.4. Different impacts on the existing financial system
Although the initial application of the two stablecoins will focus on weak areas of the existing fiat currency services, the new stablecoin is used in a smaller application range and its spillover effect is therefore smaller. The circulation of Libra stablecoin is global. Although it will focus first on the people who are not able to access financial services, its actual application in the real world will certainly not be carried out in full accordance with the expectations of the project. Therefore, the impact of Libra on the existing financial system can be very large. In addition, since Libra stablecoin is pegged to a basket of fiat currencies and accepts fiat currency collateral to generate Libra stablecoins, it will certainly have an impact on existing fiat currencies. This will bring a lot of uncertainty to current fiat currencies, which is not something that central banks like to see.