Sometimes, “stablecoins” and variants such as “algorithmic stablecoins” function like historical names, as they refer to projects that call themselves stablecoins, such as Basis Cash, Elastic Set Dollar, Frax and their clones.
The word “stablecoin” can be used as a logical description for “a cryptocurrency designed to have low price volatility” and has “stores of value or units of account,” or “a new type of cryptocurrency that often have their value pegged to another asset… designed to tackle the inherent volatility seen in cryptocurrency prices,” or a currency that can “act as a medium of monetary exchange and a mode of storage of monetary value, and its value should remain relatively stable over longer time horizons.”
On the more metaphysically speculative end, some have defined a stablecoin as “an asset that prices itself, rather than an asset that is priced by supply and demand. This goes against everything we know about how markets work.”
Circularity is the core issue, as I see it. The alleged deficiency of Bitcoin (BTC) as money and a vague definition originally inspired a host of stablecoin projects. The design features of these projects have now been incorporated back into the stablecoin definition.
Haseeb Qureshi — a software engineer, author and famous altruist — defines a stablecoin as simply a price peg. Yet, it is not obvious that anything with a peg should bear the name of stablecoin. Ampleforth has a “peg” and has been bucketed into the stablecoin category. The founding team routinely clarifies that it is no such thing.
So, who is right?
Another example of just what exactly is “stable” in a stablecoin — the peg or its value? Wrapped Bitcoin (wBTC) is perfectly pegged to Bitcoin — one wBTC will always be one BTC. Is that a stablecoin?
According to the original motivations for creating stablecoins, BTC is not a stable means of exchange, even though Bitcoin is the canonical “store of value” asset.
Having clarified the problem — that no one knows how to define or recognize a stablecoin — the rest of this essay outlines a solution. It provides a well-defined description of value as a relational property, namely, “value in terms of a measurement unit.”
Using this description, I then comprehensively classify all digital assets along two dimensions — risk of loss, or the probability of realizing a decrease in value, and risk of gain, or the probability of realizing an increase in value. We can then precisely and logically define stablecoins: assets where the risk of loss and risk of gain are both zero.
I call this a risk-defined stablecoin.
It is clear that today’s algorithmic stablecoins have a risk of loss but no risk of gain. Thus, not only are they not stablecoins, but they are terrible financial assets. I finish by considering whether it makes sense to expand the concept of a risk-defined stablecoin to a more general concept centered on expected value; an expected-value stablecoin is one where the probabilities of loss and gain, weighted by the magnitude of loss and gain, are perfectly offset and net out to zero.
I conclude that the complexity and ergodicity of such a concept rule it out as a useful stablecoin definition.
What is value?
What “value” means is not entirely clear, as evidenced by continuing debates about the “true” rate of inflation. We can ask: Value in terms of what?
That is, we decide to treat value as a relational property between the object being measured and the thing doing the measuring. It is like asking for height — do you want it in inches or centimeters? For our purposes, can we define a function that maps an asset to a set of numerical values in a chosen unit? I call it: Value.
For example, if the chosen unit is the U.S. dollar, and the item is a bag of chips,
We could just as well have written Heightinches(table)=35in.
Risk of loss, risk of gain
The value of an asset changes over time, so we can expand our Value function to reflect the idea of “the value of an asset, in terms of a unit, at a certain time” by adding the time (t) at which we are measuring value:
We can define risks as the probability that, at a randomly chosen time in the future, the Value function would show a decrease or increase in value.
In practical terms, this means that if I convert the asset into my chosen unit, I would realize a loss or a gain.
A risk-defined stablecoin
We now have enough to create a well-defined description for a stablecoin. A stablecoin is an asset where the risk of loss and the risk of gain are both zero. That is: p(gain)=p(loss)=0.
This means that if I sell the stablecoin asset in the future, I will neither experience a loss nor gain in value, as measured in my chosen unit.
The Boston Consulting Group’s famous matrix was invented by the company’s founder, Bruce Henderson, in the 1970s. With some rearrangement, we can repurpose the Boston Consulting Group growth-share matrix to classify all digital assets by their risk of loss and risk of gain. The four categories are still stars, dogs, unknowns and cash cows.
A star investment, with no risk of loss but a risk of gain, is rare nowadays but abundant in hindsight, such as when one regrets selling Bitcoin back in 2010. Stars also exist in the imagination. Such was the case with the investors in Bernie Madoff’s fund. But those kinds of investments quickly reveal themselves to be dogs. Dogs are sure losers — there is no risk of gain, but if you hold them long enough, the risk of loss becomes an actual loss.
Star investments are most abundant in hindsight when we can no longer buy them:
I’d be a *billionaire* now if I hadn’t sold the 55,000 bitcoins I mined on my laptop in 2009-2010 way too early (mostly before 2012). That is regretful, but then again, with the early bitcoiners we set in motion something greater than personal gain.
— Martti Malmi (@marttimalmi) December 18, 2020
Unknowns are your regular investments — you could be up or down in terms of value, depending on the day. Most digital assets, even Bitcoin, fall into this category. Lastly, cash cows are investments that have minimal risk of loss or gain. They are dependable. We can now take those projects that have been named as stablecoins to see which truly fit.
Let’s put some major digital assets and stablecoins into the gain-loss matrix.
Projects called algorithmic stablecoins are stablecoins in name only. Because of their multiple token designs, they have no risk of gain — as all of the new supply is given to investors — but holders retain a risk of loss.
Price peg is not enough. The expected value of owning an asset could be positive or negative, but it is not zero. Another lesson is that it is important to specify a unit when discussing value. If our measurement unit is the U.S. dollar, then wBTC is not a stablecoin. But if we are defining value in terms of BTC, then wBTC is the perfect stablecoin.
Lastly, risk assessment is hard. I’ve received pushback about classifying Tether (USDT) as a stablecoin, given its counterparty risk.
These are all valid points.
Except under extraordinary circumstances, no stablecoin is truly free of the risk of loss. Perhaps Tether is a cross between a dog and a cow.
Nonetheless, it should be clear that certain projects egregiously appropriate the term “stablecoin” in a bid to grant investors a risk of gain while saddling holders with a risk of loss. Since no sane person would hold these assets on their books, however, it is almost certain that these dogs will go extinct.
An expected-value stablecoin?
Astute readers will have noticed that expected value is not just a function of the probability of loss and gain — the magnitude of losses and magnitude of gains is just as important.
For example, assume I have a fair die. If I roll a six, I win $60. If I roll any other number I lose $6. The expected value of rolling the die is:
But can we expand the concept of a risk-defined stablecoin into that of an expected-value stablecoin? In other words, would it suffice for the expected value of holding an asset to be zero? Using the die example above, this condition would be met if I won only $30 instead of $60. So, any time I try to convert this “DieCoin” into U.S. dollars, there is a five-sixth chance I will realize a loss in value, and a one-sixth chance I will realize a gain. But because the gain is so much larger than the loss, these cancel out.
I think this could be a clever approach that can be realized through a set of derivative contracts. However, it would lose the property of allowing holders to exit their position with minimal impact to their portfolios.
This should remind us that, ultimately, definitions are artifacts of a community of speakers. And I find it doubtful that more than a few people will find an expected value definition persuasive.
This article does not contain investment advice or recommendations. Every investment and trading move involves risk, and readers should conduct their own research when making a decision.
The views, thoughts and opinions expressed here are the author’s alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.
Manny Rincon-Cruz serves as an advisor to the Ampleforth project and is a co-author of the protocol’s white paper. Manny is a researcher at the Hoover Institution at Stanford University, where he helped to launch and currently serves as the executive director of the History Working Group.
$250M Fund to Invest in Polkadot and Cardano Launched in India
FD7 Ventures, the cryptocurrency-oriented fund that recently vowed to dispose of its BTC holdings for ADA and DOT, has set up a $250 million micro-fund focusing on investments in teams working on the ecosystems of Polkadot and Cardano.
FD7 Goes to India for DOT and ADA
Based in Dubai, UAE, FD7 is a crypto-oriented investment fund with over $1 billion in assets under management (AUM). The firm recently announced somewhat bold plans to dispose of $750 million of its BTC holdings and allocate the sizeable amount into ADA and DOT.
At the time, the company’s Managing Director blasted the primary cryptocurrency and highlighted the potential for Cardano and Polkadot to further rise in popularity and utilization.
FD7 Ventures doubled-down on its belief in the two projects, according to a more recent press release. It reads that the firm has opened an office in Bangalore, India, with the primary focus of offering financial assistance to Polkadot and Cardano.
To do so, FD7 has established a micro-fund targeting $250 million to invest in teams working on the two projects. The statement described this move as part of the overall “strategic road map to build its presence in Bangalore” and further reaffirm its support for Polkadot and Cardano.
“Positioning our new location where we have in Bangalore gives us a home-field advantage to tap into some of the world’s best future talent in blockchain and cryptocurrency development.” – commented Prakash Chand, Global Managing Director at the company.
The new venture plans to invest $1-5 million across 50 companies yearly, with about “thirty percent of those Polkadot and Cardano ecosystem-based companies receiving secondary investments of $5-20 million.”
NFTs Are the Future
The statement also touched upon the growing craze of non-fungible tokens (NFT) and Polkadot’s role in some particular cases. More specifically, it breached the recent partnership between the famous YouTuber Paul Logan and Bondly, which resulted in an impressive popularity boost.
“Just look at Bondly, which is built on Polkadot. It literally blew up overnight when YouTuber Paul Logan sold more than $5 million worth of NFTs in just 24 hours. This is not just a space to watch but one which is proving its investment-worthiness with almost daily records being set with increase use cases for non-fungible tokens that support cryptographic art, collectibles, gaming, and more.” – said Chand.
China restricts crypto mining in Inner Mongolia
China has been at the forefront of developing its digital yuan or DECP [Digital Currency Electronic Payment] but has continued to maintain a distance from the cryptocurrency ecosystem. The growing crackdown on Bitcoin mining firms in China has been impacting the sentiment in the area and according to reports, it has now extended a ban on mining projects in Inner Mongolia.
The country will end all cryptocurrency projects associated with mining. This decision followed China’s effort to meet energy efficiency targets. The large amounts of energy consumed by crypto and other industries like steel, coke, and methanol production have resulted in the government’s stringent decision to ban mining activity in the region.
The autonomous region of Inner Mongolia has been a hub for cheap power due to which the mining industry was drawn to it.
The aim of the region has been to cut emission per unit of gross domestic product by 3% this year and gradually control the massive boom in the consumption of standard coal. Although small, the region accounted for 8% of global Bitcoin mining hash power.
China has a 65% hold of the total network hash power allotted to Bitcoin and the above map highlighted that among other regions Xinjiang was the highest contributor to the hash rate in a month.
The abundant supply of coal and the relative remoteness of the region made it more convenient and cheap for miners to set base here. However, no strict actions have been taken to curb this problem by the Chinese government. If the country continued its mission to become more energy-efficient, it won’t be long before miners have to find alternatives to cheap electricity available in various regions in China.
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Central bank digital currency a mixed blessing, says RBI
India’s central bank has recognized the potential benefits of central bank digital currencies but not without including a few pitfalls.
The Reserve Bank of India offered its assessment of CBDCs as part of its report on currency and finance issued on Feb. 28.
As part of the report, the RBI noted that several countries are exploring the creation of their own sovereign national digital currency.
According to the central bank’s report, CBDCs can help to promote financial inclusion and transactional transparency. The RBI also stated that national digital currencies could be useful as an instrument of monetary transmission by helping to engineer public consumption towards specific categories of products and services.
Detailing the benefits of CBDCs, the RBI also remarked that digital counterparts to sovereign fiat currency could be used by central banks to pump “helicopter money.”
In its analysis, the RBI also expressed concerns about the potential negative impacts of CBDCs on the legacy financial system, noting:
“CBDC is, however, not an unmixed blessing — it poses a risk of disintermediation of the banking system, more so if the commercial banking system is perceived to be fragile.”
For countries with significant credit markets, the RBI argued that CBDCs could threaten the primacy of commercial banks as the primary channel for the transmission of monetary policy.
As previously reported by Cointelegraph, India is looking to emulate China in creating its own CBDC. According to RBI governor Shaktikanta Das, the central bank is “very much in the game” of developing a digital rupee.
However, the RBI report did not include any details about the central bank’s digital rupee project. In another portion of the document, the central bank did concede that internationalization of the rupee was inevitable but added that such a move would complicate monetary policy formulation and implementation.
With several countries looking to create their own sovereign digital currencies, CBDC interoperability is becoming a concern among stakeholders. Meanwhile, reports indicate that China’s digital yuan will have a more domestic focus.
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