Here's The One Non-Speculative, Non-Ponzi Use Case in Crypto
It flies in the face of the anti-fiat, 'number go up' crypto ethos
Americans are stunned by 8.6% inflation, the highest in 40 years, but in the developing world, there are countries where consumer prices rise ten or twenty percent per month. In places like Argentina, Nigeria, and Venezuela1, rather than collecting more taxes or cutting spending, the government instead balances the budget by printing currency and expropriating its purchasing power, causing runaway inflation. People protect themselves from this informal tax (inflation) by holding as little local money as possible.
If you’re part of the economic elite, dodging inflation means converting local currency into stocks, real estate, and durable assets (especially cars). If you’re not, it means holding small amounts of foreign currency like the U.S. dollar. Unfortunately, opening a US bank account is impossible for most people in the world2, but that’s changing thanks to crypto —>
Enter Stablecoins
Crypto offers anyone with a phone and an internet connection an alternative to American banks: stablecoin tokens that hold a 1:1 peg with the US dollar. Anyone with savings or disposable income can protect themselves from runaway local inflation by holding USD-equivalent coins.
Ownership of stablecoins is recorded on public and permissionless databases (blockchains) that are also distributed, slow and expensive. However, in practice, this means that anyone can create a digital wallet on these platforms without asking authorities for permission and without ID or even a mailing address. After that, buying stablecoins with local currency is relatively straightforward.
The size and user friendliness of both peer-to-peer (P2P) and centralized crypto marketplaces like Coinbase has improved significantly over the past few years, and they require minimal documentation to be used. P2P exchanges have no know your customer (KYC) and anti money laundering (AML) checks at all, while centralized exchanges still only have limited checks. And unlike Paypal and Zelle accounts, self-custody crypto wallets can’t be frozen or closed on a whim. Governments can shut down centralized exchanges (like Nigeria did last year), but P2P exchanges can continue running even when banned.
People always wonder whether crypto has any non-speculative, non-ponzi use cases. Observers always ask if there are any tangible products that are easy to explain that grow organically, without advertisement and the allure of getting rich quick. Well, this is it!
The product is simply buying and holding stablecoins as a partial hedge against inflation in mismanaged developing economies. The product is regulatory arbitrage to get people that couldn’t access USD before a new kind of synthetic USD. This is good and useful and I’m mostly glad it happened.
But if you think about it, stablecoins are —>
The Antithesis of Crypto and Web3
Crypto is meant to replace fiat currencies — the ‘unbacked’ money that’s supposed to be under the arbitrary control of unelected, unaccountable and politically motivated bureaucrats — but stablecoins have expanded access to the US dollar globally. Now Cubans and Iranians and Chinese people can get their hands on the greenback. Rather than undermining Uncle Sam’s fiat money, crypto has actually broadened its reach!
Separately, web3 is supposed to be about owning the projects that you use, but none of the leading stablecoin projects are publicly traded companies or have volatile tokens whose value is linked to the success of the project. If any of the largest stablecoins 10x or 100x in size, retail investors won’t profit – they’ll only ever hold the $1 tokens they bought in the first place. Even if the major stablecoins succeed wildly, there will only be ‘number go down’ for retail investors holding their dollar-linked tokens thanks to 8.6% US inflation!
In any case, demand for stablecoins from high-inflation countries probably —>
Has A Low Ceiling
It’s just not the case that an entire poorly managed emerging market can boycott the government’s inflating currency and convert all local money into US dollars (or stablecoins) in one go. Who would want to buy all the local currency? Where would all the dollars (or dollar equivalents) to replace it come from?
For a developing country to gradually replace a fraction of the local currency with dollars (or stablecoins) without government support, it needs sustained net dollar inflows. Technically, it needs a current account surplus – more foreign inflows than outflows – to consistently accumulate US dollar assets.
However, only about half of all countries have current account surpluses, and only a small fraction of those countries have runaway inflation. If this tiny subset of countries use just a fraction of their surplus to buy stablecoins, that’s not much demand. Plus, people fleeing inflation in emerging markets won’t always be net buyers of stablecoins; at times, they will be net spenders. Overall, net new demand from this ‘buy and hold’ emerging market inflation hedge will be limited.
Many emerging markets are already partly dollarized or dollar-indexed in the real estate sector and for high-value transactions (like car sales). Stablecoins could deepen dollarization in lower-value sectors if they take off, reducing the power of local monetary policy. Still, for now at least, it’s unclear that stablecoins will reach enough scale in developing countries to weaken the hand of local central banks.
Having said all this, I can’t responsibly write about stablecoins without warning about the —>
Known and Less Known Risks
A few weeks ago we discussed Tether, the dubious company that issues the dominant USDT stablecoin. As I’m sure readers know, Tether doesn’t have formal oversight from any US regulator and has overstated the reserves backing their tokens and hidden investment losses repeatedly, leading to multimillion dollar penalties from the NY attorney general. They have a small Cayman Islands auditor and have volatile cryptocurrencies and equity investments on their balance sheet.
Unsurprisingly, they’re losing market share to stablecoins like Circle’s USD Coin (USDC) and Binance USD (BUSD), but Tether is still the leader with $66B in tokens outstanding. By now, Tether holders should know that there’s a distinct chance that the company is insolvent and that they may not recover a full dollar for every token in a ‘rush to the exits.’ Still, I fear that casual users in emerging markets are largely not aware of these risks.
Outside of Tether, there are also less obvious risks. Take Circle’s USDC, for instance, which has a market cap of $55B and is viewed as the leader in disclosures, compliance and risk management. Matt Ranger estimates that during its rapid growth in 2021, USDC kept the reserves backing its tokens as deposits in two US banks for which USDC became the single largest depositor: the tiny Silvergate Bank (SI) with $15B in assets and the still-small Signature Bank of NY (SBNY) with $121B in assets (numbers from 1Q2022).
Like all other banks, Silvergate and Signature keep some share of deposits at the Federal Reserve and lend out the rest to earn interest. This means that if there had been a run on USDC, it would have translated into a run on Silvergate Bank and Signature Bank of NY. These banks could have come under severe stress or failed, and as Frances Coppola argued, USDC tokenholders probably don’t qualify for pass-through deposit insurance from the FDIC, so it’s unclear how much stablecoin holders would have recovered. Going forward, USDC appears to be taking steps to minimize these risks3.
In Conclusion
Demand for stablecoins originally took off in developed markets to fund unsustainable, leveraged speculation on cryptocurrencies like Bitcoin and Ethereum and even riskier derivatives built on top of them. Funnily enough though, it turns out that the most compelling, non-ponzi, non-speculative use case in crypto is actually more, better fiat.
The use case is people in mismanaged emerging markets simply buying and holding synthetic crypto dollars to protect themselves from local inflation. Crypto’s grand mission to replace the traditional financial system appears instead to be extending its reach…
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Instead of cutting spending or raising more traditional taxes, these countries fund the government with inflationary financing, which usually involves a combination of central bank money printing (in the forms of loans’ to SOEs or ministries and debt purchases) and financial repression to extract loans from domestic banks and pension funds at below-market rates. This kind of inflation is essentially a (highly inefficient, regressive and distortionary) tax on holders of the local currency and wage-earners, whose purchasing power is appropriated by the government as the local currency is debased.
There is always the option of hoarding US dollars cash, but this is impractical and unsafe. Some emerging markets also offer local bank accounts denominated in foreign currency, but this is also risky. If the government suddenly needs dollars for imports or debt payments or whatever else, they can always take the dollars in the banking system via law or decree and forcibly convert accounts to local currency.
This March, USDC announced a partnership to custody reserves with Bank of New York Mellon (BK), a much larger institution with $470B in assets. They also announced a partnership with New York Community Bancorp (NYCB) yesterday, a very small institution with $61B in assets. As a result, the risk of the primary reserve-holding bank failing will likely decline as they diversify their counterparts. But to be clear, even well-run stablecoins have not always been risk free for retail token holders.