The Unstable Stablecoins

One of the promises the crypto sector sells is safety from inflation; it’s the easiest way to pitch Bitcoin and some other assets to a resident of a third-world country. But that hasn’t been the case lately, considering that the United States Dollar is also experiencing significant inflation.o

This research article proposes redesigning stablecoins and mechanisms to hedge against inflation and provide entrance into the crypto meta.

Raw and Unfiltered Understanding of Stablecoins

Stablecoins are one of the many blockchain products that have experienced widespread adoption. They provide a means for preserving liquidity, maintaining a mental transaction basis (the belief function), building traditional finance applications on-chain, and many other use cases.

Stablecoins are not limited to the official currencies of sovereign states. I’d define stablecoins as digital assets that mirror an underlying non-crypto-native asset to eliminate price fluctuations.

Based on “pop crypto” culture, If it’s a stablecoin, then,

• It is not native to crypto and, sadly, the default.
• It is a recognized legal tender (medium of exchange), so anybody can intuitively extend their belief systems.
• It is not volatile and can be the base currency for trades across multiple platforms.

The drill isn’t too deep for Stablecoins: maintain the peg to the underlying currency. Stablecoin provides mechanisms for maintaining its peg. It’s great for arbitragers and some protocols when Stablecoins depeg to the upside, i.e., 1 XUSDX > $1, but hell, let’s lose when the reverse is the case.

Nonetheless, after a depeg event, the mechanism should reinforce stability to fortify consumers’ belief in the stablecoin as a reliable medium for exchange.

Relevant Economic Theories for Stablecoins

Many economic theories and frameworks exist to examine stablecoins. Let’s consider monetary policies, inflation, and pricing.

Monetary Policies

Crypto nativity is a passionate statement that currently ends at off-ramping. For many on-chain participants, including myself, Stablecoins bridges the traditional monetary system and crypto.

Stablecoins affect the financial architecture of the underlying currency-issuing states’ economy and foreign exchange with participant resident states and their monetary policies, including how central banks manage monetary supply and interest rates.

Inflation

The relationship between stablecoins and inflation is quite weird, especially on the belief system part.

In third-world countries experiencing hyperinflation, some on-chain participants use stablecoins of more stable currencies to hedge against inflation, e.g. Nigerian hedging against 28.20% or Argentines hedging against  211% inflation with USD-backed stablecoins, which would be prone to the 4.1% in the last year that the USD it’s backed with experienced under sane assumptions.

Stablecoins are only as stable as the underlying currencies they’re pegged to. It’s safe to refer to them as mirrored coins instead.

Argentina's inflation rate 2018-2023 - Source: Bloomberg

Asset Pricing

Regardless of the pegging mechanism, stablecoins' value is linked to the asset backing them or algorithmic adjustments, which are critical to their pricing stability. Fiat collateralized stablecoins rely on fiat currency reserves, while algorithmic stablecoins adjust supply based on market conditions to maintain the peg.

Consequently, if crypto stands for financial sovereignty, it’d need its stablecoin, a mirror of zone strength and prosperity and maybe a unifying asset that’s not volatile.

The Need for Crypto-Native Stablecoins

Now, amid the current economic bubbles and rumours that the US is faking inflation data since the numbers hardly reflect the reality of most commodities, crypto may need a sovereign stablecoin.

The crypto values that make it a better alternative to traditional finance are:

• Safety from the Government and their control over banks’
• sovereignty from traditional finance instruments.
• Ability to hedge against inflation.
• A financially safe and inclusive environment (nothing in the crypto market in general, regardless of the asset or infra, provides an economically safe and inclusive environment).

It’s ironic how Stablecoins fulfil NONE of these promises.

Fiat-backed stablecoins aren’t safe from traditional finance instruments for government monetary policies or sovereignty and are inflation-prone.

Similarly, most algorithm stablecoins construct price stability to mirror the dollar, making them prone to similar issues. What’s the fix? There is no need for a peg; it is just a universal belief from the start and a mechanism to create value. Walk with me!

The Ideal Crypto-Native Stablecoin

Crypto-native stablecoins will offer immersion into the new meta and not an extension of the traditional. It will be true freedom for liquidity, not any form of puppeteering.

Stablecoins should represent voting for and buying into the on-chain economy for the prosperity and benefits of every stablecoin network participant.

It is particularly benefiting from the circular flow model (pop thinking about the on-chain creator economy) without any defects in distribution).

If you’re wondering how it all works, here’s an overview of these features and their intersections for stablecoin 2.0.

Crypto First Sovereignty

Stablecoins need a source of intuition. Traditionally, they’re pegged to real-world assets for “belief” and termed “unstable” when they lose the peg due to defects associated with their mechanisms.

An ideal crypto sovereign stablecoin would need an initial peg or great price discovery mechanism. Then, it shouldn’t depend on real-world assets but on the prosperity of predefined assets and generated revenue.

Stability for the Crypto Native Stablecoins

By stability, it shouldn’t be volatile; that’s one feature of traditional stablecoins that makes pegging to RWAs logical.

Ideally, stablecoins should be the currency of a new state, the crypto state/meta, and it should be tradeable against the dollar and other currencies and less volatile than regular cryptocurrencies.

Interoperable Issuance for Crypto Native Stablecoins

“Interoperable issuance” refers to mechanisms for distributing stablecoin across blockchains and platforms in general. Blockchains and platforms shouldn’t have to request native support for assets.

https://x.com/0xrooter/status/1835893657553232033?s=61

Asset issuance should be permissionless. Anyone should be able to build issuance systems and bridges that retain fungibility while maintaining and regulating distribution.

This is relatively new in crypto, with projects like Axelar and Noble pioneering true asset freedom with the Interchain Token Service and how Noble is issuing native USDC across Cosmos chains.

Interoperable Issuance and Sovereignty Births Decentralized Liquidity

Liquidity fragmentation is a by-product of having too many chains and protocols vying for prosperity without proper mechanisms to enable them to do that. Too many bridged tokens are further fragmenting liquidity regarding asset compatibility.

When we have these two features for a stablecoin or any asset, users can quickly transfer their tokens over networks and maintain full fungibility. Think Circle CCTP but with decentralized stablecoin features so nobody ever requests native tokens; instead, you build your blockchain and connect to a hub that services issuance and supply.

Algorithmic Governance Because Humans

Money is a belief system prone to manipulation, bias, and corruption.

The demerits of traditional finance, which are prone to these defects, leech into RWA-backed stablecoins, eventually affecting the sector as a whole.

Algorithmic governance for crypto-native stablecoins via smart contracts with predefined rules for battle-tested instruments would go a long way toward ensuring fairness and providing real-time adjustments.

But that’s not the blue pill; human intervention should be needed in some cases since algorithms cannot patch uncertainties, dilemmas and complex real-world events that may require adaptability.

NoteWorthy Approaches Out Now

I posted some parts of this on Twitter, had interesting conversations with some industry leaders, and found some interesting projects that are building towards the future of stablecoins.

• Resolv Lab’s $USR Stablecoin is the closest solution
• Noble’s model for USDC & USDY Issuance across Cosmos.
• Axelar’s Interchain Token Service’s token issuance and supply management.
• Shade Protocol’s $SILK Stablecoin and the DeFi Integrations.

Some, if not most, of these ideas are already being executed. I believe that this is the future of stablecoins. However, these traditional stablecoins won’t die out; they’d phase into an onboarding and off-ramping utility class.

Conclusion

I also wonder where this leads, but as this is part 1, I intend to renew it for a technical second part that would delve into specific frameworks and discuss the possible problems with decentralized stablecoins.

Till then, we can only hope that stablecoin issuing positively impacts the ecosystem in other ways.