What (most) people are missing about stablecoins and security tokens

2018 in blockchain

The most interesting blockchain developments in 2018 were around stablecoins and security tokens, at least in my opinion. There were a lot of new projects, smart people, money and surprises (for example https://medium.com/basis-blog/basis-update-ae96e3565b1d) in both areas. I find it encouraging and ironic at the same time. Encouraging because the crypto-world realized that in order to have mass adoption of the blockchain technology, it has to be more predictable, civilized, regulated and compliant. It’s ironic for the same reasons: the technology that was originally created as an alternative to the existing financial and monetary systems now has to comply with the existing financial rules and regulations (security tokens) and accept the government-endorsed, fiat money as the standard for payments ($ pegged stablecoins).

“(…) they will never take our freedom!”

The initial idea behind cryptocurrencies and ICOs was to create an alternative financial system free from the tyranny of the SEC, Wall Street, banks and the worthless fiat money that governments devalue and use as a hidden tax on people’s wealth. The brave, new, decentralized and transparent financial world, governed by the law of the immutable code, was supposed to empower the oppressed poor, give easy access to capital to the brightest; and unlock the unrealized potential and wisdom of the crowd. Well, maybe it did in some cases. There are certainly very interesting and noble blockchain projects out there. But these are scarce. The vast majority of money in the space participates in the biggest unregulated 24/7 casino ever created. And, surprise, surprise, as there are no rules, licences or customer protection, scams, market manipulations, false reporting and bad governance are prevalent. The outcome is far from fair or decentralized: for example, 87.5% of BTC is owned by only 0.66% of the wallet addresses (https://bitinfocharts.com/top-100-richest-bitcoin-addresses.html).

So, now the industry realizes that this libertarian, anarchist, wild west approach attracts only a very specific type of user and is not the best way to create meaningful, life changing solutions for the mass market. Therefore, we need to be regulated, compliant and, excuse the pun, stable. We have stablecoins pegged to fiat that will facilitate transactions and security tokens with STOs selling equity in companies instead of ICOs selling pretend utility tokens with no real utility. And that’s great for the users, consumers and investors who are more protected right now, but what do you need the blockchain for?

Electronic payments are already well developed. Equity crowdfunding is already possible without crypto tokens in many jurisdictions, including the US. Adding tokens introduces another layer of complexity, costs and friction because now you need to have the legacy infrastructure (legal and technical), the blockchain infrastructure and the interface between the two. This is true not just for stablecoins or STOs, but for every blockchain project: once you start replicating the existing structures and models, the question ‘why blockchain?’ needs to be addressed. There are specific, niche cases where tokens add extra value, but these are mainly catering to that crypto-casino community.

Where do we go from here?

I’d suggest focusing on business models and applications that are only possible with blockchain and impossible in the old world, without the blockchain. Let’s start with stablecoins. Almost all of the projects I’m aware of are trying to create stable coins. The ‘coins’ part is crucial here. Probably having been influenced by the Austrian school of economics (for some reason, the most popular school of thought in the crypto space), these projects adopted the idea that money is a commodity that facilitates the exchange of goods and services. Therefore, the first order of business for them is to create the commodity, the coin. But this approach takes us back hundreds of years where payments were about moving physical stuff around and commodity of money was used as a very simple ‘single entry accounting’ system to keep track of resources.

Since the introduction of double entry accounting — about 800 years ago in Europe — transferring value and payments happens by adjusting corresponding accounting records. This is how the modern financial systems work. Banks are the trusted, centralized third parties that keep track of these accounting records and prevent double spending. I’d suggest that a shared, distributed database of accounting records, with immutable rules and entries, not controlled by any third party is a good use case for the blockchain technology and a natural evolution of the idea of money. In this approach, money is used as a unit of account but is not required as a medium of exchange. The exchange of value happens through adjustment of the accounting records. The need for commodity no longer exists.

Additionally, this creates a situation where money and the payment systems can carry much more information about the business context of every transaction. This opens the entire spectrum of new services and applications, like traceable money used for charitable donations, real-time accounting with instant updates to financial statements, or much more accurate risk assessment of every business activity.

Having a set of trustworthy accounting records with information about payments and movements of assets enables the creation of new types of asset classes and financial instruments. Security tokens don’t have to replicate shares or bonds anymore. Instead, the value of a security token can be derived from specific business transactions. For example, derivative tokens can pay royalty on a company’s or individual’s revenue or can grant a right to a perpetual discount on purchases. In this case, the blockchain technology would enable businesses and individuals to create derivatives in a transparent and inexpensive way. This was previously only possible for regulated financial instruments and prohibitively expensive on a small scale. I’d imagine that this innovation will have a very profound impact on the economy, similar to the impact of derivatives and securitization on the financial markets.

There you go! This is what (most) people are missing about stablecoins and security tokens:

  1. replicating existing systems doesn’t make much sense; and
  2. blockchain technology enables completely new types of derivatives and the next iteration of the infrastructure we call money.

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