A brief history of the stablecoin
Those of you who have been following this blog for awhile may recall my deep and enduring disdain for the “stablecoin” concept, that is, the idea that it is possible for “crypto-economic” magic and game theory to ensure that a cryptocurrency can be reliably pegged to the value of some real asset without requiring a bankruptcy-remote contractual mechanism to ensure convertibility of the crypto-asset into the real deal (something mainstream finance already does extremely efficiently).
The first of these “stablecoin” follies was the Bitshares project, back in 2014, which claimed that blockchain alchemy could create a stablecoin called BitUSD which was pegged to the dollar and indeed pegged to any other asset (gold, silver, marmots) which users of the system chose to create. I wrote at the time that the Bitshares “USD peg” system was doomed to fail, and sure enough, 100 hours after launch the thing fell flat on its face.
I had thought that would be the end of it, either because the wider community learned from this project’s mistakes, or that some government agents would take notice of the fact that people were running around selling “shares” unconnected to a prospectus or actual shares.
None of that happened. So it was not the end.
In the intervening period, the “blockchain without Bitcoin” craze came and went and then, in early 2017, Ethereum (another scheme crafted by the hands of men) shot “to the moon,” with the coins – originally valued at something like $0.30 – shooting up to $450 a pop and a $30 billion market cap. The herd took notice and ICOs began to proliferate at an alarming rate.
By the time the SEC piped up, on 25 July, the gold rush was already well underway.
The promise of overnight riches was irresistible to both startups and their venture backers alike, legal consequences be damned, and soon afterwards startups everywhere, like untrained dogs, began leaving proverbial messes all over the field of financial regulation the world over.
In October, a scheme called Basecoin claimed to have re-discovered the philosopher’s stone of finance. As with Bitshares, the scheme creates a cryptocurrency instrument that is collateralized by itself and depends on an environment of ever-rising cryptocurrency prices and never-ending cryptocurrency collateral. I wrote about it. It’s a really bad idea.
Now we stumble upon MakerDAO. I paid very little notice to MakerDAO so wasn’t going to say anything about it, but then they decided to tell a journalist that “Preston hasn’t said anything about our project because our project is amazing.”
That made me angry.
Having taken fifteen minutes to review the MakerDAO paper, the Dai system is at its core a very simple cryptocurrency-collateralised derivative contract, with a lot of intermediate steps to confuse its buyers of the facts that (a) that contract is massively overcollateralized in the underlying cryptocurrency (which is Ethereum by default) and (b) in the event of an Ethereum black swan event the value of the underlying collateral, and therefore the value of the stablecoin, will also be wiped out.
Speaking generally, the system requires someone who wishes to obtain $100 worth of Dai to post, say, $150 Ethers’ worth of collateral. This, of course, is insane, because it would be easier for the user to simply go to Coinbase and sell his Ether for actual dollars, and he’d have $50 worth of Eth left over to go spend on other things.
The system also assumes that overcollateralising will protect the value of the Dai. Not so; it simply increases a Dai holder’s exposure to the price of the underlying Ether. If Ether gets wiped out, the Dai collateral will be worthless, so the user will have lost $150 in an effort to create $100.
Put differently, this system makes zero sense and is broken to the core: it only works if the price of Ether goes up. Cognizant that the conventional wisdom is that the Ethereum “World Computer’s” price will always go up, and it has done nothing but go up for the last 18 months, I can see how this might make sense to the MakerDAO team.
Unfortunately for them, history shows that this investment thesis has been wrong 100% of the time, and Ethereum is as user-friendly and scalable as an angry rhinoceros experiencing heroin withdrawal.
Long story short
Crypto-collateralized stablecoins are the perpetual motion machines of modern finance.
I don’t blame the developers building these things; stablecoins are just a stupid meme invented by guys like Vlad and Vitalik back in the heady, schelling-point-heavy days of Ethereum Proof-of-Concept 3 et seq. that nobody in the community possessed the requisite experience or gravitas to refute.
I refute it now. It’s a terrible goddamned idea.
A stablecoin that is collateralized by itself is a complex and fragile Nakamoto Scheme doomed to fail.
A stablecoin that is collateralized by real assets and structured correctly is not a stablecoin, but a unit trust.
That’s all for now.
Postscript, 11 December 2017
I rest my case.