All You Need To Know About Dollar-Denominated Cryptocurrencies
A well-known obstacle to the greater popularity of Bitcoin as a
medium of payment is the high volatility of its exchange value. This
volatility results from its built-in quantity commitment: because the
number of Bitcoins in existence stays on a programmed path, variations
in the real demand to hold Bitcoin must be accommodated entirely by
variations in its unit value. When demand goes up, there is no quantity
increase to dampen the rise in price; and vice-versa for a fall in
demand.
Not surprisingly, several cryptocurrency developers have thought of
creating a cryptocurrency with a price commitment–namely a pegged
exchange rate with the US dollar–rather than a quantity commitment, in
hopes of greater popularity. The aim is to create a system in which
dollar-denominated payments can be made with the ease, security, and low
cost of Bitcoin payments, but without the exchange-rate risk.
New Digital Assets
The development of “Blockchain 2.0” platforms has enabled the
launching of a variety of new digital assets, including such
dollar-pegged (and euro-pegged and gold-pegged) currencies. As we will
see, the histories of early (2014-2016) dollar-pegged cryptocurrencies
show a series of flops. But one project, Tether, has become a
late-blooming success.
Tether had $55 million in circulation as of March
29, 2017, making it the #13 largest cryptocurrency. To keep this size in
perspective, a brick-and-mortar US institution with $55 million in
deposits is a tiny bank or a mid-size credit union, and Tether is
currently only 1/300th the size of Bitcoin.
The Tether white paper explains in more detail the motivation for
developing a dollar-pegged cryptocurrency by listing advantages to
individuals using it for dollar-denominated transactions rather than
using dollars held in “legacy bank” accounts:
Transact in USD/fiat value, pseudonymously, without any middlemen/intermediaries
Cold store USD/fiat value by securing one’s own private keys
Avoid the risk of storing fiat on [cryptocurrency] exchanges–move cryptofiat in and out of exchanges easily
Avoid having to open a fiat bank account to store fiat value
In sum, “Anything one can do with Bitcoin as an individual one can
also do with” a dollar-pegged cryptocurrency, namely, “avoid credit card
[or debit card] fees,” maintain greater privacy, “remit payments
globally” more cheaply, and access blockchain financial services.
But what is the claimed advantage over using Bitcoin? It is the
expectation of wider acceptance in payments, because of the advantages
to merchants of accepting a dollar-pegged cryptocurrency over accepting
Bitcoin in a US-dollar-dominated economy:
Price goods in USD/fiat value rather than Bitcoin (no moving conversion rates/purchase windows)
Avoid conversion from Bitcoin to USD/fiat and associated fees and processes
The Flops
First we consider the projects that have flopped. Three projects were
launched in September 2014: CoinoUSD, NuBits, and BitUSD. Their pegging
mechanisms were different, and are difficult to describe briefly
(partly because they were not all entirely transparent), but two common
features are important to note.
The rate-pegging mechanisms were not programmed into a source code,
like Bitcoin’s quantity commitment, but relied on non-programmed policy
actions by a trusted central authority.
None used the traditional currency pegging method of having the
issuer hold reserves in physical dollars or dollar-denominated debt
securities. (On the NuBits mechanism see this critique by a BitUSD
promoter. On the BitUSD mechanism see this critique by the CoinoUSD
developer.)
We can examine the fortunes of each project by looking at its price
and “market capitalization” (value-in-circulation) history on the
cryptocurrency tracking site CoinMarketCap.com.
CoinoUSD
CoinoUSD, which began trading in December 2014, was developed by a
for-profit payments firm called Coinomat and built on the blockchain of
the NXT cryptocurrency. (In November 2014 NXT was the #6 cryptocurrency
with a market cap of $19 million; currently it ranks #38 with a market
cap around $13 million.)
CoinoUSD reached a market cap plateau of $2.7 million in early 2016,
but shut down in early 2016, due to a “payout glitch” that flooded
customers with free CoinoUSD units, making it impossible to maintain the
exchange value at $1. Coinomat announced a reboot in which the
erroneous payout would be reversed and said, “NXTUSD will replace
CoinoUSD completely, and enhance it,” but this appears not to have
happened. Since then it has had a market cap of zero, and its webpage at
the Coinomat site declares it “disabled until further notice.”
NuBits
The history of NuBits, also a for-profit enterprise, shows that it
gained only a similarly small market foothold. Its market cap plateaued
early on below $2.5 million, and since April 2015 has remained below $1
million. In June 2016 NuBits had a devaluation crisis, with the price
falling to 20 cents. Its rate-pegging intervention mechanism, despite
claiming many layers of reinforcement, was not robust and failed.
Although the price later returned to par, today NuBits shows very
little market activity. Since January 2017 the market cap has hovered
around only $135,000, with daily trading volume in the neighborhood of
$2000.
BitUSD
BitUSD is built on the blockchain platform of the cryptocurrency
BitSharesX. Its highest market cap plateau was around $1 million soon
after introduction, but it fell to below $200,000 in April 2015 and is
currently less than $110,000.
BitUSD uses a novel pegging system that so far has proven robust. A
piece promoting BitUSD emphasizes that “the bitUSD is an asset that is
not backed by real dollar in someone’s bank account.” (It claims this a
virtue: “We cannot trust anyone to hold and secure a physical asset so
that people can redeem it eventually. History has repeatedly shown: It
doesn’t work!” In fact, history shows the major banks in unhampered
banking systems routinely justifying the public’s trust by redeeming
their liabilities on demand for decades. Paypal works on the same
supposedly non-working model, backed by Paypal’s dollar deposits at
Wells Fargo Bank.)
By contrast, BitUSD are created through collateralized forward
currency contracts. The network provides an escrow service that credibly
ensures repurchase (or “redemption”) of the BitUSD at or near par.
Someone who wants to acquire BitUSD, say in order to buy from a seller
who prefers a dollar-denominated medium of exchange, offers a contract:
so many BitShares (hereafter BTS) for a certain amount of new BitUSD.
Under the BitShare network rules, the acquirer must not only pay at
the outset in BTS but also agree to post collateral in BTS equal to the
value of the bid. If the bid is accepted by another network participant,
explains the BitUSD white paper, “the collateral and purchase price are
held by the network until the BitUSD is redeemed” by some third party
repurchasing it. The acquirer of BitUSD thus puts 200% collateral into a
contract “that only allows access to these BTS when the BitUSD are paid
back.” In effect the acquirer is shorting the dollar price of BTS.
“BitUSD is an asset used to hedge a position in BitShares against
changes in the price of USD and is not supposed to have an exact 1:1
exchange rate with USD.”
Note that the new BitUSD units are initially 200%
collateralized not in dollar-denominated assets, but in BTS. If BTS fall
25% or more against
David Ogden
Entrepreneur
