The stablecoin anathema

1/11/2019

By: Izabella Kaminska

The rise and popularity of stablecoins is subjecting the crypto world to mass cognitive dissonance.

On one hand, stablecoins are to be adored because they were born out of the cryptocurrency movement, are distributed on blockchains and — in the case of Tether at least — support the entire crypto economy.

On the other hand . . . argh . . . they’re centralised and . . . double argh . . . they’re supported by evil fiat systems and . . . triple argh . . . they’re kind of an admission that people really just want fiat (albeit wrapped in a regulatory arbitrage advantage).

For the radical distributed guys, it’s too much of a problem to ignore.

Small surprise there are now people in cryptoland seriously committing themselves to solving this non problem. [Allelujah!]

Introducing PegNet: the world’s most convoluted stablecoin offering.

PegNet follows in the great cryptocurrency tradition of The People’s Front of Cryptocurrency eventually turning on the Cryptocurrency’s People Front.

The pattern evolves as follows. After years of denying that any problems exist with the original incarnation of [insert cryptocurrency product here], criticism from non-crypto sources is abruptly realised to be correct, and assimilated. Said realisation leads to a vast new product array claiming to solve said identified problem, plus brutally honest accounts of what was wrong with incarnation number one. The process eventually leads us back to the standing system.

PegNet is no different.

Where stablecoins were a solution to bitcoin’s inherent volatility and dependence on dollar funding revenue . . . PegNet’s press communique notes:

''... there are inherent flaws to Stablecoins in their current format, although they are transferred over a decentralised distributed ledger, the collateral they are based on is centralised and dependent on reserves that require trust of the issuer.''

PegNet naturally aims to “solve” this problem, in the context of accepting assets as broad as fiat currencies (including the Chinese yuan!! and Mexican peso), lots of other cryptocurrencies (because a stablecoin based on cryptocoin makes so much sense) and good old silver and gold.

Yet the pathway to the solution on centralised custodial relationships is anything but comprehensible.

Here’s the spiel:

''hese contradictions within the burgeoning Stablecoin sector has led to the formation of PegNet, the world’s first ever mineable stablecoin network that is non-custodial, auditable, self-issued and decentralised.''

An info graphic-based PPT shared with Alphaville is equally opaque about how those custodial dependencies are going to be busted. Which is odd, because you’d think it would be paramount.

Here are two particularly fun slides:

When asked to explain how the custodial dependency is distributed we were told:

''There is no custodial control in PegNet. There are 3 ways in:

1. Buy PegNet assets on an exchange
2. Mine PEG
3. Burn FCT which is gone forever and gives you pFCT in the same address. You're the only one with the private key (hopefully) so you have full control over your assets at all time''

And that:

''The coins are stable within the protocol due to the oracles' posted prices and on exchanges as a result of arbitrage.''

Call us slow or too mainstream, but we have no idea how that solves for the awkward problem of having to store collateral somewhere. Fiat needs to be kept in somebody’s account, crypto has to be stored in somebody’s wallet and gold has to be stored in somebody’s warehouse.

You can’t stabilise a fund’s NAV (and a fund with a NAV is in essence what stablecoins are) with a protocol and price reference rate. The units either derive value from underlying collateral assets (in which case you need to know where they are and who they’re controlled by) or from a credit guarantee (in which case you need to know who is offering the guarantee and how creditworthy they are).

Meanwhile, if the collateral is so broad based that it includes a range of assets that is as far reaching as cryptocurrencies, we’re basically talking about a mutualised fund structure where the value of coins is linked to the mark-to-market value of the underlying collateral divided by the number of coins in issuance.

But there’s no stability guarantee in that, nor any decentralisation.

Further questions regarding how PegNet achieves stability and manages collateral drew this response:

''PegNet tokens are mineable via PoW and miners are rewarded with Peg tokens in return for submitting price data from external sources.

Miners subscribe to various market APIs and submit the prices for 30 assets (including the dollar and bitcoin). When a price has been agreed by other miners PegNet sets the value of pegged bitcoin called pBTC.
If someone has pegged dollars on the network they can exchange them for pegged BTC for a tenth of a cent free from middlemen.

Essentially people add value to the PegNet (Bitcoin, dollars and Euros etc) which is then “pegged” into the system and enables them to make stablecoin transactions that are generated through these proven contributions and decentralised through the Factom protocol which is built on top of Ethereum.

Stability is further enhanced by exchanges that list pegged assets through arbitrage.''

We’re baffled by the gobbledegook.

Though there is one point of possible worthwhile innovation: the idea of mining with an incentive to submit price data from external sources.

A major problem in the Ethereum smart contract revolution is the system’s dependency on third party reference rates, which no one can easily police because, guess what, they’re provided by third party suppliers.

This problem has bugged the community for a long time. But it’s also probable that it’s impossible to solve because of the nature of market structures. Any market, whether naturally over-the-counter or forced into decentralisation by regulation, does, and always will, suffer from the fragmented pricing problem.

This has become well evidenced in the recent high-frequency trading controversies, which showed that the arbitrage mechanism alone is not enough to align fragmented markets in a level playing field in a way that leads to a fair marketplace. In a fragmented structure, some will always have an advantage over others simply due to the realities of space, time and co-location.

In short, getting a true and fair reference rate in a highly fragmented market is always going to be problematic. All the more so if huge profits or losses in separate linked value systems are dependent on those rates being set one way or another.

Could a mining incentive to provide prices that match everyone else’s prices in exchange for rewards solve this problem?

It’s probably worth asking the British Bankers’ Association. Because they’ve kind of tried this before. It was called the London Interbank Offered Rate. A.k.a. Libor.

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