Stablecoin battle is for heart of internet economy

The cryptocurrency market was roiled this month by something known as ‘stablecoins.’ These are an odd hybrid and among the most controversial and least-understood cryptocurrencies, but they’re important to the future of the internet economy.
Up until October 10, the previous month had been quiet for cryptocurrencies. That’s when an intense burst of trading just before midnight New York time pushed Bitcoin prices down by $400 to below $6,200. Then just after midnight five days later an even larger burst pushed prices up by $800 to nearly $7,000.
That’s where stablecoins, which attempt to hold a fixed price to a fiat currency, come into play. The five most prominent do this by holding one US dollar in trust accounts for each coin issued. On October 10, the largest stablecoin, Tether, fell from $1 to 92.5 cents.
Most crypto is trading slightly higher than the beginning of the month, with Tether around 99 cents and the other stablecoins around $1.01. Since there wasn’t much net movement, it’s tempting to dismiss the short frenzies as noise from immature trading markets. But I think we witnessed a key battle in an important war.
The issue is how the internet economy will be managed. From a technical standpoint, there’s little doubt that some form of crypto/blockchain/ smart-contract technology will be used. The vision of most crypto enthusiasts is that no external reference value is needed. Bitcoin and other cryptocurrencies derive value from demand for their use.
A less radical view, popular on Wall Street, is cryptocurrencies are just alternative forms of traditional currency. A Bitcoin is $6,600 — its market price — in a form convenient for certain transactions. Coins, bills, checks, bank wires, credit-card receipts, vouchers, microchip payments and PayPal balances are ways to hold dollars, useful for different transactions. Bitcoin is just one more, and a defective one because its value changes so much.
Stablecoins represent an intermediate concept. They link the internet and traditional economies without full integration. The four stablecoins that now trade at a premium to par force the strongest links. All require users to qualify for US bank accounts, meaning users can pass “know your customer” and anti-money laundering tests. All are subject to US regulation and taxes. All could be frozen or seized for unrelated transactions. For example, you might buy one of them to invest in Bitcoin, but when you sell the Bitcoin your coins could be seized on the claim that you bought or sold Bitcoin with a disfavored person, or that your transactions link to a disfavored person many steps away. “Holder in due course” rules protect you with physical dollars but they do not exist for crypto.
Tether, the oldest and biggest stablecoin, is losing market share to the others. It’s closer to the free internet view: no know-your-customer or anti-money laundering questionnaires, and no way for the coins to be seized without your private key. But the bank account backing the coins could be seized. Tether administrators must walk a careful line to provide the transparency necessary to inspire confidence from users without providing such strong and transparent links that the banking relationships they need will be cut off by regulators or risk-averse bank compliance officers. So far Tether has managed well, growing to $2.6 billion (briefly dropping below $2 billion during its crisis), despite deep
suspicion on both sides.
It appears that after fierce infighting among traders, the verdict is that crypto users prefer the known devil of regulation to the unknown devil of an unregulated stablecoin — and that the preference for regulated stable coins is a modest positive for overall cryptocurrency prices. The fundamental nature of the internet economy is at stake here, and I have no doubt there are more and bigger battles to come.


Aaron Brown is a former Managing Director and Head of Financial Market Research at AQR Capital Management

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