Illustration: Barry Downard
Selling so-called utility tokens to raise money instead of begging venture capitalists to take equity ownership in their ideas has enthused entrepreneurs in the crypto world since mid 2017, but the fad may now have run its course.
Back in June 2017, the big breakout month for ICOs, entrepreneurs raised $645 million equivalent through sale of utility tokens for their businesses, despite these granting no ownership, no claim on these businesses’ assets or profits, and no source of value except a bet on the tokens of those few companies that eventually succeed in being used a lot.
In that same month, such firms raised just $80 million in conventional venture equity. The peak month for ICOs was January 2018, when new blockchain-based companies raised $2.43 billion through this method, 10 times as much as through venture equity.
By this September, however, the ICO game looked like it had entered its final inning. Firms raised just $279 million, suggesting that since the peak, “monthly ICO activity is down 90%, which of course looks a lot like Ether’s price performance, but with a three-month lag,” as analysts at Autonomous Next said.
So, is all this cryptocurrency nonsense nearly over?
While the dominant design so far typically has been asset-backed with off-chain collateral … there is still a clear hunger for a more digitally native stablecoin- Garrick Hileman, Blockchain
The recent boom and bust in bitcoin, Ether and other cryptocurrencies took place against the background of a sharp turn away from the initial concept of a new form of money – to be used as a medium of exchange and maybe a store of value, if not a unit of account – into highly speculative investments. No one wanted to spend bitcoin when it was soaring in value and making holders rich. The proliferation of ICOs, with many hundreds of new utility tokens emerging as traded instruments to bet on new businesses, rather like a new form of high-risk equity, propelled this shift.
Now many of the leading thinkers in the crypto world are trying to retrace their steps and find their way back to the original idea of using blockchains as low-cost, high-speed rails for moving money in a new tokenized form.
Anyone who hasn’t lost interest in crypto already will be hearing a lot more about stablecoins in the months ahead. Venture capitalists have not given up on crypto yet. With ICOs in abeyance, they are back. In August this year alone, they put $1.65 billion into crypto investments, and stablecoins are a growing area of interest having attracted $350 million of conventional venture capital so far.
In stark contrast to bitcoin and other widely traded cryptos, stablecoins are designed to reduce price volatility, indeed to peg their value to an anchor, in many cases the dollar, and not deviate from it. There are various mechanisms to achieve this, including the simplest of requiring users to deposit fiat currency in accounts maintained off blockchain, to then create stablecoins representing these real dollars, pass these via blockchain to other users who may eventually redeem them for real dollars, burning the old tokens in the process.
It is an obscure corner of the crypto asset market, to date dominated by a single instrument, Tether, responsible for 93% of aggregate stablecoin market value and 98% of stablecoin trading volume.
That high volume arises because participants in the crypto world want to trade in and out of other crypto-assets through a stable anchor. The crypto exchanges – 50 odd at the last count – trade leading crypto currencies in pairs, and active participants often trade bitcoin and others against Tether, typically buying into Tether when they sell out of bitcoin before then moving into Ether or Litecoin, Tron, Neo, Monero or any of the others.
The crypto world is just too volatile to trade directly between two crypto assets that may each be shooting up and down in value on any given day, although it is worth remembering that recent price falls are modest in the history of bitcoin, which in the dim and distant past, pre-2013, saw plenty of 50% falls in a single day.
Of course, it is this volatility that has recently put off conventional investors in the regulated financial world from dealing in crypto, even though many were attracted by its climb in the second half of 2017 and looking for ways in.
Could it be that stablecoins, a little-followed feature of crypto trading, may become the mechanism that finally draws real world users in?
Today, stablecoins together represent just 1.5% of the total market value of all crypto-assets, according to researchers at the digital wallet company, Blockchain, which is backed by investors including Google Ventures, Lakestar and Virgin and boasts former Barclays chief executive Antony Jenkins and former SEC chairman Arthur Levitt on its board. Blockchain, the company, is aiming to build a comprehensive institutional offering for investors in crypto assets, providing both market access and research.
In September, it published a report into stablecoins that drew on feedback from 57 such ventures. Most are designed to remain stable to the dollar, as well as to other leading fiat currencies, including the euro and yen, with some pegged against commodities to target inflation and a few against bundles of other cryptos.
Its researchers sought input beyond Tether from 22 other stablecoins already in production, as well as from backers of 34 more preparing for launch.
They come in two types: those that are asset-backed either by fiat currency held off blockchain, or in some cases by assets including cryptos held on blockchain; and the newer and more complex algorithmic stablecoins based on code that aims to replicate the actions of a central bank in managing money supply by producing new coins in response to changing supply and demand.
“As we say in the report, it is highly unlikely that the perfect stablecoin design exists at present,” Garrick Hileman, head of research at Blockchain, tells Euromoney. “But they already punch well above their weight, with bitcoin and Tether the most traded crypto-currency pair and Tether now the number-two traded crypto asset after bitcoin itself.”
However, in mid October something alarming happened to Tether. Crypto exchanges began quoting it below one dollar, down at 95 cents on some before a recovery to 98c. Crypto insiders point out that high turnover in wilder crypto currencies when they are rallying can impact stablecoins, as crypto enthusiasts sell them to buy more exotic stuff.
Bitcoin rallied in mid October.
While Tether has been stable at $1 for over a year, it has previously seen spasms of volatility, briefly trading down to 92c in April 2017 before heading up to $1.05 as use of Tether began to rocket when trading in all cryptos took off.
It is possible, however, that some users are now abandoning Tether for newer stablecoins designed to improve on it.
In the past, questions have been asked about exactly where its dollar reserves are held in custody and whether these fully back every Tether coin minted or constitute a mere fractional reserve.
In June, the company behind Tether published a report from Washington-based law firm Freeh, Sporkin & Sullivan (FSS), which it had commissioned to inspect bank account documentation and conduct a randomized inspection of the numbers of Tethers in circulation and the corresponding currency reserves at Tether’s two unidentified banks.
The report concludes that: “FSS is confident that Tether’s unencumbered assets exceed the balance of fully-backed USD Tethers in circulation as of June 1, 2018.”
Blockchain, in its report into stablecoins, points out that any asset-backed cryptocurrency is only as secure as the ultimate custodian of the underlying assets. Depositing these in a known banking institution that is secure, reputable and trusted would represent a big improvement to Tether.
The safer the bank, the better, of course.
Blockchain says that the company relies on legacy banking institutions in Taiwan and perhaps Puerto Rico to custody its reserves. Tethers are therefore subject to the same credit and counterparty risk inherent with any standard bank deposit.
An ideal candidate custodian would be a true ‘narrow bank’ in which assets are as liquid as its liabilities, meaning that deposits are invested one-to-one in safe government bonds or held in cash with no fractional reserve banking.
We are now in a new period of heightened competition among stablecoins.
“While the dominant design so far typically has been asset-backed with off-chain collateral – which doesn’t sound very sexy but might appeal to conventional investors – there is still a clear hunger for a more digitally native stablecoin, and as much money has been raised recently for these kinds of algorithmic projects as for asset-backed attempts to improve on Tether,” adds Hileman.
Growing venture investment in this proliferation of new stablecoins is the clue that these could be the instruments that help create a tipping point for much broader crypto-asset adoption.
Users really are crying out for them. In September, Euromoney reported on the World Bank’s first blockchain bond deal.
Investors submitted orders into a book managed on blockchain through which the issuer allocated bonds that will operate as smart contracts and trigger instructions for payments. Just one element remains off-chain: the exchange of payments, including for primary settlement and to meet subsequent interest falling due.
“We would have liked to use a central bank digital currency, if that had been an option, in the atomic settlement in change of ownership of the securities together with associated transfer of funds,” Paul Snaith, head of operations for capital markets, banking and payments at the World Bank, tells Euromoney. “But until that is possible, we did not wish to use any of the cryptocurrencies, partly because of all the well-known KYC [know-your-customer] and AML [anti-money laundering] concerns, but also their harmful impact on the environment.”
For now, cash settlement and payments are all off chain.
Credible stablecoins, with tested mechanisms for pegging their value to the currency of denomination for a bond deal and verifiable audit trails for collateral backing held in custodian accounts with regulated banks could be an answer for issuers and investors seeking to execute capital market transactions via distributed ledger.
Beyond the closed world of banking and capital markets, other companies are looking at stablecoins as a way to complete blockchain-based processes with exchange of payments: insurance being just one example.
As Blockchain points out in its report, a delayed or cancelled flight is a public record that can be queried by a ‘smart flight insurance’ blockchain application. If a flight is delayed or cancelled, then the smart contract might automatically pay the claimant, eliminating the painful claims process that hundreds of thousands of inconvenienced passengers forget or fail to complete each year.
In travel and many other smart insurance use cases, it would be preferable to denominate the smart contract with a stablecoin, rather than a more volatile cryptocurrency, to keep the whole process on-chain.
“Axa announced a pilot for smart insurance on flights from Paris to the US a year ago,” points out Hileman. “I’m sure the insurance companies don’t want to cannibalize themselves, but I think smart insurance is inevitable. Axa may be thinking: ‘If we don’t do it, who else might come along and take our business?’”
The key question, of course, remains: can stablecoins remain stable? In October, Tether deviated from its peg.
Could large international banks use a stablecoin like USDC for more efficient and less costly cross-border reconciliations? It might take time to get there, but you bet they could- Marieke Flament, Circle
Others have found maintaining stability difficult. For example, NuBits, launched in 2014, was one of the early stablecoins that broke its one-to-one peg to the dollar in 2016 and again in 2018, falling victim to the swings in bitcoin and other cryptos, rising above $1 when bitcoin and the rest sold off and users fled into NuBits and falling below the peg when crypto investors ploughed everything they could into bitcoin on the way up.
Crypto sources tell Euromoney this exposed the risks of a stablecoin backed with only fractional reserves, most held in bitcoin and other cryptocurrencies. The search is on for a better design.
Circle is a global crypto finance company founded in 2013 by Jeremy Allaire and Sean Neville with a view that money should move and operate like the internet – open, secure, free and everywhere.
Circle has raised investment of $250 million through five funding rounds from backers that include Goldman Sachs, Chinese bitcoin mining company Bitmain, Breyer Capital, IDG Capital and CICC.
Euromoney reported at the end of August on its Circle Pay app for low-value payments and its crypto wholesale trading and exchange operations. At the end of 2017, Circle also established an open source consortium of 30 partners active in the crypto markets called Centre, supported by $20 million of investment, which in late September this year unveiled one of the most closely watched new stablecoins, called USDC, for US dollar coin.
Running on the Ethereum blockchain, this lets individuals and institutions deposit dollars from their bank accounts, convert those dollars into tokens usable everywhere the internet reaches (subject to the token’s compliance controls) and redeem USDC back into dollars.
Researchers at Blockchain point out that Circle is operating within the regulatory framework of US and international money transmission laws and working with established banks and auditors. Although these had not yet been identified when Euromoney went to press, Centre will audit its members and be audited itself by respected firms.
Circle is regulated by FinCEN as a licensed money transmitter and has obtained appropriate licences from various US state banking departments and is seeking them from international regulatory authorities.
“Centre is an open source consortium that is defining standards and policies, as well as enforcing a governance scheme for issuers of Centre-enabled technology,” Marieke Flament, managing director for Europe at Circle, tells Euromoney. “To be a member of the Centre network you need to pass certain requirements. You need to be a regulated entity with full compliance of KYC and AML, and have trustworthy banking partners and auditing procedures in place.
“All customers that want to tokenize their dollars into USDC, or redeem them back into dollars, will need to be KYC and AML approved.”
Flament explains a little of the thinking behind its design: “We have seen a huge need for a regulated and audited stablecoin that is fiat-backed. Circle is the first approved issuer of USDC on the Centre network. Thirty companies, including various crypto exchanges, wallets and projects, are already using USDC and more will join. In the future, members of Centre will likely launch more stablecoin projects pegged to other fiat currencies.”
With the unpegging of Tether once again raising the question whether, if all the existing asset-backed stablecoins were fully audited, there would be a true one-to-one relationship against fiat currency reserves, USDC has enjoyed rapid early adoption.
On October 16, the day after uncertainty was circulating about Tether, it was reported that USDC trading volume on exchange platforms in the past 24 hours had surpassed the volume for the prior week.
These are early days, of course, but in three weeks since launch, 10 more companies had announced their support, bringing the number using USDC to 40. Market capitalization has grown to more than $25 million.
That is still a mere fraction of Tether, but a big vision is driving USDC.
At USDC’s launch, Circle's Allaire and Neville explained the importance of this new service in realizing their idea of fiat money and financial contracts executing on top of distributed public network infrastructure, which would allow users to share value as instantly and easily as they can access content in web browsers or exchange messages in email.
They explained that: “A fundamental building block of this vision is the tokenization of fiat currency itself, through what are now referred to as fiat stablecoins. A safe, transparent and trustworthy layer for fiat to operate over open blockchains and within smart contracts is a necessary precondition to the broader and more revolutionary potential of a crypto-powered global economy.”
Pretty much any crypto exchange or wallet that wants to let its users transact in USDC can do so. At launch it was set to be used on DigiFinex, CoinEx, KuCoin, OKCoin, Coinplug and XDAEX.
And there are other use cases. Joao Reginatto, Circle’s director of product management, listed a few of these at USDC’s launch.
Origin is building a platform that enables the creation of decentralized, peer-to-peer marketplaces for fractional use goods and services. Think of ride-sharing and home-sharing, for example. Obviously, the platform might benefit from a reliable cryptocurrency that helps reduce transaction fees and promotes free and open commerce. At the end of September, Origin identified USDC as its stablecoin of choice to help address the problem of unstable cryptocurrency prices in marketplace businesses.
BlockFi extends loans backed by crypto-assets as collateral, and USDC will help BlockFi build a better user experience with loans effectively denominated in dollars.
Other platforms, such as BitPay, in merchants’ payments, and FOTA, in over-the-counter derivatives, could be key in weaving USDC into even more mainstream financial services, according to Reginatto.
But crypto exchanges will always be the first battleground for stablecoins. Some crypto exchanges will list anything that pays them. Others will look for likely volumes. Certain exchanges, such as Poloniex, which Circle itself owns, will apply sterner tests of provenance of backers, finances and business plans.
Poloniex, of course, was among the first to list USDC trading in pairs against bitcoin, Ethereum and Tether.
There is a certain irony that, in order to eventually achieve broad acceptance among conventional financial institutions and populations at large, stablecoins first need to prove their worth among crypto adherents as the stable leg in crypto-to-crypto trading and an eventual bridge for some users back into the regular, fiat currency world.
Many crypto diehards are attracted to a next generation of algorithmic stablecoins now preparing for launch instead of to fiat-backed stablecoins with reserves held off-chain.
Perhaps the most interesting of these algorithmic models is Basis. Back in April, Intangible Labs announced that it had raised $133 million through a private placement supported by Bain Capital Ventures, GV, Stanley Druckenmiller, Kevin Warsh, Lightspeed, Foundation Capital, Andreessen Horowitz and others to support Basis, a stable currency managed by a set of algorithms that operate as a virtual central bank on the blockchain.
Basis is intended to peg at roughly one-to-one against the dollar. If it gains acceptance as a popular medium of exchange in the crypto world and increases in value to, say, $1.10, the system will print more Basis tokens to increase supply and so reduce the price.
If the price falls below $1, the code will issue bonds worth one basis token each, use the proceeds to buy existing Basis tokens to reduce supply and so bid the price back up, later repaying bondholders when Basis tokens trade above par.
Our retail clients are seeking to access and trade digital currency products in the same way they do with traditional capital markets – through a legitimate, regulated and transparent exchange- Steve Quirk, TD Ameritrade
It is a complicated, seigniorage-based system that looks quite decentralized. The potential upside is that it has less of the counterparty risk of an off-chain fiat backed model, where users may ask: are the off-chain reserves really there to create new stablecoins, in which custody banks are they held and what laws govern the claiming of these reserves?
“The ultimate question for a user of any of these stablecoins is how confident can they be in the stability mechanism,” says Hileman. “How they look at that may depend on different users’ location, what they want to use a stablecoin for and their point of view on scalability.
“Some, like Circle, are trying to keep designs simple. The search for a better Tether has already led to TrueUSD (TUSD), an off-chain, fiat-collateralized stablecoin on Ethereum, which holds no dollar reserves itself but with these rather in escrow at registered partner banks.”
Users must pass KYC and AML checks when wiring dollars to these third-party banks while also providing an Ethereum address to receive their TUSDs.
TrueUSD has quickly become the second most actively traded stablecoin after Tether and holds obvious appeal for those crypto market investors happiest in the regulated financial world.
“But remember the original blockchain ethos of censorship resistance and code is law,” says Hileman. “Plenty of users may prefer algorithmic stablecoins. That’s why we believe there may eventually be between five and eight stablecoins that succeed.”
Flament says: “The latest designs for stablecoins may eventually be looked on as intermediate steps. Remember, we had SMS for a long time before we had WhatsApp.”
We are in a period of florid experimentation with stablecoins. Some users are now even talking about stablecoins backed with on-chain collateral baskets of… other stablecoins. Stablecoins may eat themselves, perhaps?
Maybe it’s not so crazy.
“One thing sceptics underestimate is just how much effort the promoters of stablecoins will devote to maintaining stability,” says Hileman. “Without that, they lose credibility. And all the stablecoins are in it together. We might see coordination across stablecoins, just like we sometimes see between fiat central banks.”
Back in June, Agustín Carstens, general manager of the Bank for International Settlements, gave an interview to Basler Zeitung later translated and posted on the BIS website, in which he was asked about bitcoin and whether or not it was a good thing that it had got young people interested in how money and the financial system works.
Not so good, it seems.
“My message to young people would be: stop trying to create money,” said Carstens. Carstens sees cryptocurrencies as unwelcome competition.
If his exhortation sounded condescending he tried to explain.
“Central banks are trusted, and that trust is something they have built up over decades and for which there is no substitute right now,” he said. “Trust is a valuable commodity. It is easily destroyed, but winning it takes time. Money has become established. Young people should use their many talents and skills for innovation, not reinventing money. It’s a fallacy to think money can be created from nothing.”
But the original question was a good one. Some of the smartest minds on the planet are now thinking deeply about what money is, how it works, what central banks and other intermediaries do and could it all work better.
It is an interesting question at what level of daily turnover in stablecoins pegged against fiat currencies, central banks might seek to intervene and what rights or powers they would have to do so.
There is another point that Carstens overlooks.
As well as everything else that they do, central banks compete with each other in a largely open market place. At the highest level they compete for seigniorage through enabling the widespread use of their currencies as the denominator for trade and commodities, for example. The question of whether or not any other currency could compete with the dollar as a global medium of exchange is at least being asked today.
Central banks also compete commercially with their payments systems. They have operated digital currencies for decades, which are open only to the large commercial banks, while the rest of us are relegated to being customers of those banks in turn.
Instead of asking what they can do to close down cryptocurrencies, smart central bankers would be better advised to consider what they might learn from them.
Ordinary investors are still interested. It is not just specialist tech venture fund managers breathing in the pungent air around Silicon Valley coffee shops and then devoting their customers’ millions to algorithmic central banks.
In October, TD Ameritrade, the online US brokerage with 11 million customer accounts and $1.2 trillion of client funds under management, made a strategic investment in ErisX, a regulated derivatives exchange and clearing organization that will include digital asset futures and spot contracts on one platform.
Steve Quirk, TD Ameritrade
“Our retail clients are seeking to access and trade digital currency products in the same way they do with traditional capital markets – through a legitimate, regulated and transparent exchange,” says Steve Quirk, executive vice-president of trading and education at TD Ameritrade. “That’s precisely why we chose to invest in ErisX – to make digital currency products more accessible to retail clients.”
The notion that bitcoin is only for drug dealers, arms dealers and trolls seeking to influence democratic elections is already rather tired.
The crypto world is splitting into two large factions. One faction, the crypto diehards, is devoted to censorship-resistant ideals, inimical to regulated financial systems and rule of law. This is now leading them to build algorithmic central banks. Watch out for them, Agustín. It’s not just money these young people want to reinvent.
But there is another faction.
“More and more of the large crypto players do, in fact, want regulation,” says Flament. “They understand the importance of KYC, AML and consumer protection. In order to see more and more large financial institutions participate, regulation is needed.”
Critics of bitcoin and blockchain often deride them as solutions in search of a problem. But there is an obvious use case for the biggest banks.
“Could large international banks use a stablecoin like USDC for more efficient and less costly cross-border reconciliations? It might take time to get there, but you bet they could,” says Flament.
A version of this article was originally published on October 11, 2018 and updated for the November issue of Euromoney magazine