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The Return of the Stable Coins


The most important benefit that Bitcoin and Blockchain Technologies have brought to us is a low-entry barrier to deploy our own currency and financial ledger. This means that, now, we can easily implement the concepts of Free Banking.

Free Banking is the system where each bank or organization is free to issue their own currency. Also, these banks are subject to no special regulations beyond those applicable to most enterprises [1]. In a Free Banking system there is no “lender of last resort”, no bailout, so each bank is competing with other banks to ensure they have the most trust-worthy and stable currency they can be. There is no government insurance in case of default, then the bank has the incentive to not over-extend their leverage, also know as fractional reserve system [2]. Otherwise, will go bankrupt in case of turmoil. Trying to only accept one currency with a centralized control only allows for human bias and resource management inefficiencies. In the Free Banking system, is also a responsibility of the bank to use security measures to avoid counterfeit money.

Same as the central banks, in a free banking system each bank can use their control over the supply to control the price of their notes. As price-stability is a desirable feature, central banks and free banks will try to have the most stable currency to attract consumer savings and corporate holdings. The main tools for price control are periodic, for example daily, monetary base adjustment, and interest rate adjustment [3].

Of course, in our brave new world of cryptocurrencies, the expected supply control is expected to be delegated to an emergent distributed network to avoid centralized bias. The author has presented some preliminary ideas on using smart contracts for algorithmic monetary base adjustment, including experiments on historic Bitcoin prices with encouraging results [15]. In the next section, we will discuss why these developments make sense in a crypto-economic sense.

A Basic Principle

A basic principle of stable coins or free economy in general is that prices cannot be fixed without a cost, and this cost results in bankruptcy risk because strict control cannot be enforced forever, and costs increase during volatile market conditions.

So, we can argue that sound stable cryptocurrency systems are those which reduce the volatility and increase predictability of prices without pegging the price to a specific value. We call these sound supply control systems: organic monetary base adjustment stable coins.

A famous of non-organic case of adjustment was on infamous Black Wednesday in United Kingdom [4]. This country had joined an European exchange called European Exchange Rate Mechanism (ERM) that include prices limit controls for European fiat currencies. Allegedly, legendary investor George Soros and a group of another hedge fund managers bet against central bank’s ability to control the currency. They noticed the inflation was not negligible, the British pound was too richly priced against the German mark and the ERM control system included a minimum desired price for the British pound. Soros made approximately 1 billion pounds on this operation [5].

The moral of the story is that if you want to place a permanent barrier in the price of a currency you are inviting investors to bet against that barrier standing up and then punch the barrier until it falls. Some governments implement temporary pegs to another currency. An exception of a long-term viable peg can be when the currency is backed but an almost monopolistic commodity holder supplying the currency. So, in the later, they have a stronger defense against attacks, due to being backed by real assets. For example, this is the case of oil and currency in Saudi Arabia [6], pegged to US dollar.

Some Stable Cryptocurrency Approaches and their Weaknesses


Tether (ticker USDT) is a cryptocurrency that is pegged to the US dollar. They use a mechanism, called Proof of Reserves (PoR), that might as well be an oxymoron. Yes, you are right, is like a regular bank, they are backing their digital USD with real economy USD (also digital in some pre-blockchain sense). Like classical banks, there is some veil of secrecy and mystery around how much reserves they have and who is supplying it [7,8]. Centralization involved in reserves has also been a target of critics and hackers at least in one occasion [9]:

“Yesterday, we discovered that the funds were inappropriately removed from the Tether Cash Portfolio by malicious action by an external attacker. $ 30,950,010 USDT was withdrawn from the Tether Treasury Portfolio on November 19, 2017 and sent to an unauthorized bitcoin address.”

There is counterparty risk here, if we found someday that there are not enough USD to back the USDT. Current USDT can be found to account as much as 1.6 billion.


This approach uses a dual-coin system where one coin, called stable-coin, will be pegged to the USD. Another coin called vol-coin is used as collateral and can fluctuate in price [10]. Vol-coins are actual currency, but the stable-coin can assume negative values because these are a form of something called contracts-for-difference. These contracts, stable-coins, are just a zero-coupon bond collateralized by at-least 2x its 1$ value in vol-coins, plus some excess collateral amount to ensure that he has enough BTS locked away even if the price relative to USD drops. Negative stable-coin is debt, positive is ownership of the debt.

As you can see there is no counterparty risk like with Tether, since the network locks funds on itself [11]. But there is a systemic weakness:

“risk lies in the possibility that the exchange rate between the dollar and BTS may move such that even the excess collateral held by the least-collateralized position is insufficient to cover what is owed. BitShares proposes that in such a black swan event, all open positions would be forced to close, purchasing back the coins and destroying all outstanding bitUSD at the most recent price. Given the extreme and persistent volatility in cryptocurrencies, these black swan events would either be relatively common or extremely expensive to protect against, with average collateral coverage likely exceeding 150% when a new position is opened.”

MakerDAO’s Dai

Dai is like Bitshares on steroids [12]. The design has a system with 5 different roles for users and a stable coin that follow a basket of international currencies. Instead of vol-coin as collateral, one can use any of the coins in the approved list of collateral coins, for example Ether.

A significant difference is how Dai handles liquidations. When the position falls below the liquidation ratio for the collateral being used, Dai positions are liquidated. In such situation, the Dai system sells an excess of a third kind of asset, the MKR token, a token for investors that want to receive fee dividends from the Dai system. This way the system is protected from black swam price swings when all positions might be liquidated.

A weakness of this system is that people is expected to create Dai either when the coins used as collateral are expecting a raise in price or there is a lot of volatility, so people are willing to pay the premium for the stability.  So, there might be demand for Dai in the short-term, but after the prices stop rising so aggressively or volatility of the entire Crypto-economy becomes smaller there is a long-term smaller incentive to use the Dai system.

Current Developments

Basis is a current development that shows some promise [13]. There is still a lot of interest in stable coins. In this case, some commentators have been very skeptic because they are trying to mimic Consumer Price Indices or US dollar using oracles and an algorithmic Central Bank [14], something they say is regressive.

If the just try to mimic the US dollar they better be ready to show some reserves like Tether, or if the plan to track a basket of assets or US dollar without reserves just supply expansion and contraction then they need to provide proof that their algorithmic supply adjustment is not biased and has similar or less volatility than the Index.

As we noticed before is very difficult to have an asset pegged two-way with a different asset, unless you have a partnership with US and Saudi Arabia, so a commodity reserve is backing you. Basis will most likely have better chances of succeeding if they just try to mimic the volatility, of the Index, dampening extreme crypto-swings, not the exact price. Is not a holy grail, but if they show a reasonable economic and decentralized cryptographic algorithmic alternative will be an improvement on the current state of affairs [15] and throw more light at the end of the Cryptotunnel.

The Future

We believe the future is organic coin supply adjustment using decentralized general-purpose blockchains and endogenous metrics such as NVT ratio, i.e. network fee volume in USD divided by coin market cap in USD, and transaction volume. NTV ratio provides a metric of how much the coin is overpriced or underpriced with regards to the business of miner’s fees. Big NVT ratio means the price of the coin is to high for a smaller miner fee business, and a small NVT ratio means that the coin is underprice compared to a, relatively bigger, miner’s fee business.

But there is no need to include USD or fiat currencies here. NVT ratio, for example for Ethereum, can be detached from US dollar because we can just compute using Ethereum fee in ETH divided by total ETH already mined and free in the market as circulating supply. No need to use fiat currency baskets or collateralized contracts. The author has provided a small Proof of Concept (PoC) of and organic-growth Ethereum token that uses number of transaction as an indicator of economic activity, thus inflating or deflating supply in a pro-rated per-wallet implementation [16,17].

We believe there is still stable and sustainable light at the end of the tunnel.

This article is also available in spanish.


  1.  Larry J. Sechrest, Free Banking: Theory, History, and a Laissez-Faire Model, Ludwig von Mises Institute, 1993.
  2.  Jean-Charles Rochet, Microeconomics of Banking, MIT, 1997.
  3.  Ferdinando M. Ametrano. Hayek money: The cryptocurrency price stability solution, SSRN (August 13), 2016.
  4.  Steve Schaefer, How George Soros Broke The British Pound And Why Hedge Funds Probably Can’t Crack The Euro, Forbes Magazine, 2015.
  5.  David Litterick, Billionaire who broke the Bank of England, The Telegraph, 2002.
  6.  Kati Pohjanpalo & Ye Xie, Currency Pegs, Bloomberg QuickTake, 2016.
  7.  The Mystery of The Bitfinex/Tether bank, and why this is suspicious, Bitfinexed Blog, 2017.
  8.  Tether Goes Berserk For 1 Billion USDT, The Bitcoin Papers Series, CryptHQ Blog, 2017.
  9.  Tether (USDT) Has Been Hacked!, Machhour Youssef, 2017.
  10.  Vitalik Buterin, The Search for a Stable Cryptocurrency, Ethereum Blog, 2014.
  11.  Christopher Georgen, Dangerous volatility and why we need a stable cryptocurrency, Topl Blog, 2017.
  12.  Nick Tomaino, Stablecoins: A Holy Grail in Digital Currency, The Control Blog, 2017.
  13.  Basecoin: A Price-Stable Cryptocurrency with an Algorithmic Central Bank.
  14.  Preston Byrne, Basecoin: the worst idea in cryptocurrency, reborn, Preston Byrne’s Blog, 2017.
  15.  Peter Rizzo, Basecoin Revealed: A16z, MetaStable Seek Crypto Holy Grail With Stable Token, CoinDesk, 2017.
  16.  Jose Orlicki, A Stable Coin with Pro-rated Rebasement and Price Manipulation Protection, arXiV pre-print, 2017.