The Role of Stablecoin in Decentralized Economy
*This article is related to the 'The Role of Stable Coin in Decentralized Economy: HTTP of Money’ session at Korea Blockchain Week 2023.
Disclaimer: This article is intended for general information purposes only and does not constitute legal, business, investment, or tax advice. It should not be used as a basis for making any investment decisions or relied upon for accounting, legal, or tax guidance. References to specific assets or securities are for illustrative purposes only and do not represent recommendations or endorsements. The opinions expressed in this article are those of the author and do not necessarily reflect the views of any affiliated institutions, organizations, or individuals. The opinions reflected herein are subject to change without being updated.
1. The role of stablecoins in decentralized finance
Cryptocurrencies are transforming the financial sector by providing a transparent and decentralized trading system. However, the volatility of cryptocurrencies has been a significant barrier to their mainstream adoption. Historically, volatile assets have been viewed as a means of investment or speculation, not as a means of exchange. Stability (not just the stability of the system, but the stability of the value) is essential for mainstream adoption of crypto, and this is where stablecoins come in. Stablecoins should be the foundation of a decentralized financial system, just like HTTP was the foundation protocol of the web.
2. Stablecoins and HTTP
- HTTP and the Internet: HTTP, which stands for Hypertext Transfer Protocol, is the underlying protocol for all data exchange on the web. HTTP has provided a standardized infrastructure for computers to communicate with each other. The problem with underlying protocols is that they change periodically, making them unreliable to the users who use them, but HTTP is the most primitive infrastructure of the Internet, minimizing change and making it reliable to users. The stability and reliability of HTTP as an infrastructure protocol played a pivotal role in the rapid spread of the Internet. (For an explanation of HTTP, see Governance Minimization by Fred Ehrsam, Managing Partner at Paradigm)
- Stablecoins in the blockchain ecosystem: Stablecoins are a type of cryptocurrency designed to have a stable value, as opposed to the large volatility seen in common cryptocurrencies such as Bitcoin and Ethereum. They are typically issued by a centralized entity holding physical reserves, or by over-collateralizing with a volatile but trusted cryptocurrency (such as Ethereum). While algorithmically valued stablecoins were once popular, the demise of the Tera blockchain, the poster child for algorithmic stablecoins, has diminished the position of algorithmic stablecoins, so nowadays, stablecoins are issued in two ways: via HTTP and via the Internet, blockchain, or web.
HTTP and the Internet, or blockchain or Web3 and stablecoins. There are obvious similarities. Both have stability and immutability as their core values, both have an infrastructure nature, and both are necessary for mass adoption. So why are stablecoins specifically an important infrastructure for Web3?
3. The Importance of Stablecoin in Decentralized Economy
(Stablecoin Dominance vs. Ethereum | Source: Glassnode)
Stablecoins play an important role in the Web3 economy (or blockchain economy, or decentralized economy) by providing a stable and reliable means of exchange. Stablecoins are important because they can be used as a store of value, which is very important because it allows individuals and businesses to transact in cryptocurrencies without having to worry about the extreme price fluctuations that other cryptocurrencies experience. For example, if you get paid in Bitcoin and the price of Bitcoin drops significantly before you can convert it to fiat, you could lose a significant amount of money. However, stablecoins can eliminate this risk by providing a stable value that is less prone to sudden fluctuations. If this is the case, cryptocurrencies can be utilized by entities that have been reluctant to pay and receive payments in cryptocurrencies due to volatility.
Stablecoins can also be used as a means of payment, just like traditional fiat currencies, which means that they can be used to purchase goods and services, pay bills (without the need for separate invoices since they are recorded as on-chain data), and transfer funds between individuals and businesses without the need for intermediaries such as banks and PGs (although, as we will see later, there are no guarantees that this can be done with stablecoins as they are subject to strict regulation).
4. Stablecoin as the HTTP Standard of Decentralized Economy
Stablecoins can be thought of as the HTTP standard of Web3. Just as HTTP is the protocol that powers the internet and enables seamless communication between different devices and networks, stablecoins are very similar in that they provide a standard unit of value that can be used across different blockchain platforms and applications. This interoperability makes stablecoins an attractive option for businesses that want to transact across borders or on different blockchain networks.
In fact, here are the chains that currently issue USDC and USDT, the assets that represent stablecoins:
- USDT: Ethereum, BNB Smart Chain, Tron, Omni, Solana, Algorand, Avalanche, EOS, Liquid Network, Polygon, Tezos, more.
- USDC: Algorand, Arbitrum, Avalanche, Ethereum, Flow, Hedera, Solana, Stellar, Tron.
The reason they can issue assets on multiple chains is because, as mentioned above, they provide a standard unit of value ($1) that can be used on multiple platforms. In this respect, HTTP and stablecoins are similar.
5. Benefits of Stablecoins
Stablecoins offer a number of benefits to users in the Web3 economy. The benefits of stablecoins include
- Stability: Stablecoins are designed to have a stable value, making them a reliable store of value and a useful medium of exchange.
- Accessibility: Stablecoins can be accessed by anyone with an internet connection, making them a powerful financial tool for countries with poor financial infrastructure. This accessibility is not only valuable for countries with poor financial infrastructure, but also for countries with complex financial systems.
- Speed: Transactions using stablecoins can be processed quickly and efficiently, making them ideal for use in peer-to-peer transactions and cross-border payments. This is because stablecoins are designed to be used on blockchain networks, which are inherently faster and more efficient than traditional payment systems (assuming, of course, that they are regulatory safe, as we'll see later).
- Transparency: The underlying assets of stablecoins are often audited and transparently disclosed, providing users with an additional level of security and trust. This is especially important for investors who want to know that the stablecoin is backed by real-world assets. In fact, Circle, the operator of USDC, and Tether, the operator of USDT, have their assets audited on a quarterly basis.
6. However, there are still issues to be addressed.
(USDC Coin Depegged | Source: Bein Crypto)
- Price Pegging: The biggest challenge for a stablecoin is maintaining its value against an underlying asset or basket of assets. If users lose confidence in the stablecoin's ability to maintain the peg, the value can drop dramatically. Aside from the Terra issue I mentioned earlier, USDT and USDC, which are backed by real dollar assets, or assets equivalent to the dollar(treasury bonds, etc), have also often failed to maintain their value, causing market disruption and loss of public trust. Of course, USDC and USDT quickly recovered their value and regained the market's trust. However, this does not guarantee that depegging will not occur again in the future.
Regulatory concerns: As stablecoins grow in popularity, they will come under increased scrutiny from regulators concerned about potential systemic risk or use for illegal activities. Strictly speaking, use for illegal activities is likely to be limited to privacy-focused stablecoins (see a stablecoin called Silk), and to a lesser extent to more advanced ones. while more realistic regulations will be AML and KYC and inefficiencies due to different taxation policies in different countries. I mentioned above that stablecoins are more efficient than regular wire transfers, but that's only in the absence of regulation or with efficient regulation. If regulations vary from country to country and are not standardized, using stablecoins may be more inconvenient than using the existing financial infrastructure.
Stablecoins are an important part of the Web3 economy, providing individuals and businesses with a stable and reliable means of exchange and a store of value. Stablecoins can also be an attractive option for businesses looking to transact across borders or on different blockchain networks, as they allow for seamless transactions without the need for intermediaries. As the use of cryptocurrencies continues to grow, stablecoins will play an increasingly important role in shaping the future of finance, but there are still many challenges to overcome. For stablecoins to become truly stable assets, they need to 1) have clear regulatory guidelines and 2) stabilize their value so that users can consistently rely on them. However, these two aspects are still lacking, which is why they have not yet become a trusted protocol like HTTP.
However, if stablecoins can accomplish these two tasks, we may be able to really start talking about the democratization of blockchain and the Web3 economy.
Four Pillars is a global crypto research firm based in Seoul, consisting of the most influential blockchain researchers in Korea. Through robust research and governance skills, it helps various market players easily onboard to the blockchain industry by offering high-quality research articles while supporting protocols in their expansion into Korean and global markets.
Writer: Steve Kim, Co-Founder and CEO at Four Pillars
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