If there’s a word coming up over and over again when talking about cryptocurrencies it’s volatility. And it’s a good reason to make the case for “Stable — Coins”
Definition: A stable coin is meant to be a crypto asset that has a stable price or a stable purchasing power.
This is part I in a series where you’ll learn more about Stable Coins (crypto-currencies)
Gold Standard Period
As you print more money the value of the money gets inflated, and for this reason the gold standard was introduced.
The gold standard was suspended twice during World War I, once fully and then for foreign exchange. At the onset of the war, U.S. corporations had large debts payable to European entities, who began liquidating their debts in gold. With debts looming to Europe, the dollar to British pound exchange rate reached as high as $6.75, far above the (gold) parity of $4.8665. This caused large gold outflows until July 31, 1914, when the New York Stock Exchange closed and the gold standard was temporarily suspended.
During the Great Depression, every major currency abandoned the gold standard. Among the earliest, the Bank of England abandoned the gold standard in 1931 as speculators demanded gold in exchange for currency, threatening the solvency of the British monetary system.
Silver Standard
The United States adopted a silver standard based on the Spanish milled dollar in 1785.
Silver certificates continued to be issued until late 1963, when the $1 Federal Reserve Note was released into circulation. For several years, existing silver certificates could be redeemed for silver, but this practice was halted on June 24, 1968.
Finally, President Richard Nixon announced that the United States would no longer redeem currency for gold or any other precious metal, forming the final step in abandoning the gold and silver standards. This announcement was part of the economic measures now known as the “Nixon Shock”.
Quick history lesson:
France sent a warship to New York harbor in early August 1971 with instructions to bring back its gold from the New York Federal Reserve Bank. It was, after all, French President Charles de Gaulle who remained consistently skeptical about the US dollar, saying at a press conference on February 4, 1965, that it was impossible for the dollar to be “an impartial and international trade medium . . .
After August 15, 1971, the value of the dollar floated against other major currencies, thereby relieving the pressure on the world’s major reserve currency but also removing the earlier discipline to use that responsibility carefully.
Why this happened?
To have money to fund wars, to build industrial complexes they needed more money, to give more to the pensions, to the state employees etc. By this they undermined the currency and gives all the fake, free, easy money to the bankers. Some of the effects of this action: the gap between poor and rich becomes bigger and bigger.
Market Manipulation on Silver & Gold
By using Futures and ETF paper claims are created.
Investors who are interested in owning the precious metal may want to consider buying shares in a gold exchange-traded fund (ETF). These funds are managed by “gold experts”.
An ETF, or exchange-traded fund, is a marketable security that tracks a stock index, a commodity, bonds, or a basket of assets. Although similar in many ways, ETFs differ from mutual funds because shares trade like common stock on an exchange. The price of an ETF’s shares will change throughout the day as they are bought and sold. The largest ETFs typically have higher average daily volume and lower fees than mutual fund shares which makes them an attractive alternative for individual investors.
So instead of you buying physical gold, that will bring the price up very fast, now you can buy paper version.
There’s an estimation that there are between 300 and 500 owners for the same physical ounce of gold that exists. (other source 528 owners of paper gold pointing to the real one).
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How crypto price can get manipulated ? Let’s learn 2 new words. One is Commingling and the other one Rehypothecation
Let’s imagine this:
You own a house. and you rent it to Person #1.
Then Person #1 says that he owns a house and rents it to Person #2, now there’s 4–5 persons that rent that house and just one house.
Rehypothecation
Tired of so much text? No problem, here’s a short video explaining what this is
Rehypothecation is the practice by banks and brokers of using, for their own purposes, assets that have been posted as collateral by their clients. Clients who permit rehypothecation of their collateral may be compensated either through a lower cost of borrowing or a rebate on fees.
With rehypothecation, the asset in question has been promised to an institution outside of the borrower’s original intent. For example, if a piece of real estate functions as collateral on a mortgage loan, and the lender pledges the asset to another financial institution in exchange for a loan, if the mortgage lender fails, the second financial institution may make a claim on the real estate.
While this schema goes good with physical properties it doesn’t work so well on crypto.
Let’s take the example of Bitcoin Cash.
BCH is free for every Bitcoiner who had any amount of BTCs and were also holding their private keys under their custody prior to the fork.
Now, post-fork, such Bitcoiners can simply use those BTC private keys to claim their BCH in a BCH-supported wallet.
For example, if you had 1 BTC, then after the split/fork, you will now have both 1 BTC and 1 BCH; in other words, your coin holdings have doubled as both coins now have the same private keys.
If you have rehypothecation then how do all the 5 people having that paper, claim their Bitcoin Cash ? there’s just 1 Bitcoin Cash, not 5.
Commingling
Commingling means that the CCP or custodian will hold client collateral (bitcoins, in this case) in a commingled, or “omnibus account,” rather than segregating them for each client in their own wallets. Commingling also centralizes cryptocurrency holdings to a single account, thereby making the account an attractive target for thieves and hackers.Now imagine a hack on such a honepot.
You need to have a notion of commingling if you want to create a stable coin.
Stable Coins
Crypto that has the price linked to some stable asset, usually USD or EUR but it can be Bitcoin or Ethereum.
Right now there’s >30 projects in development in stable coins.
There can be two types of stable coins.
Reserved back functions like paper money used to be when it was backed by gold/silver. Thether is one of them, TrueUSD is another.
Tether has repeatedly claimed that they would present audits showing that the amount of tethers outstanding are backed one-to-one by U.S. dollars on deposit.They have failed to do so
TrueUSD It provides monthly attestations issued by Cohen & Company, a top 50 U.S. public accounting firm, giving the value of their reserves.
Algorithmic stable coins they use software to match supply with demand and maintain the peg to USD (or other).
The simple way to match increasing demand is to mint more coins so supply must increase so there isn’t any appreciation in the value of the stable coin.
As the value decreases there has to be a mechanism by which the supply must be reduced again to try to bring the price back up.
One use of stable coins is when you want to trade out of a crypto, and store that money, but not necessary take the money into a bank account. You can sell bitcoins for dollars which would be a huge taxable event. Another use is that companies that make insurances are more likely to work with stable coins than with a volatile crypto.
Thether is the second most tradable crypto
A smart stable coin should be independently stable, not pegged to USD, EURO or other fiat. It should be backed by a diversified portfolio that include several crypto assets like BTC, ETH, some real world assets and some securities.
The idea is to get a portfolio that itself is stable and has a real value
But at the beginning it’s hard to start like this, so I’m going to show you how to do it.
Part I — Designing the system
At the beginning you should peg to EURO or USD and hold in a smart contract couple of crypto assets.
A user that holds your stable coin, can redeem from your portfolio a dollar or euro worth of your crypto assets.
The value of those tokens hold in a smart contract is used to implement the exchange rate peg between your stable token and the USD.
Second thing you need is that your portfolio needs to be overcapitalized to around 400% because it’s assets that they hold are volatile.
If their value fluctuate, this doesn’t stop the algorithm to fully back the tokens. In the future as you add more assets to your portfolio and it becomes more stable the over-capitalization can go lower.
You need to hold collateral that have solid backup and use collateral types that are not volatile
What if your portfolio goes down ?
Simple: you don’t maintain parity. ex: 1 token = $1 and you have 50% hold in vault. Users will allow to convert to 1 token per $0.5.
About KYC
If you want the user has to go though a KYC process in order to get your coin you get the benefit of allowing your company to be in the business with banks.
The big downside is that it limits the access to your system. Many users want privacy for their crypto and some of them don’t have access to banks.
If you don’t require KYC, you get the drawback that banks don’t want to participate or they don’t want to be known that they hold your assets.
In the next chapter I’m going to show you an example of a smart contract that acts like a vault and it’s used as collateral for your ERC20 token.
