Why Stablecoins? Part 1 — Protecting People’s Money
By: Robb Henshaw
Tags: Inflation, Banking, Crypto, Economics, Cryptocurrency

As highlighted in our last post, we believe the right stablecoin protocol can alleviate the suffering of people who have lost their money to hyperinflation. For those who live in developed countries with stable fiat currencies, it’s tough to imagine that in distressed monetary zones, most people have no available protection against the rapid devaluation of their money. But hundreds of millions of people worldwide live in these areas, and are forced to watch the value of their life savings evaporate.

Enter stablecoins, which can spawn parallel, peer-to-peer economies, where citizens leapfrog repressive, local currency controls and transact entirely through stable, digital money.

Defined by the late economist Dr. Phillip Cagan as a monetary defect where the price of goods and services increases by over 50 percent a month, hyperinflation is currently wreaking havoc on six of the world’s economies, according to accounting firm Ernst & Young. In a July 2018 report, E&Y identified those distressed economies as: Angola; Argentina; South Sudan; Sudan; Syria; and Venezuela.

Either through mismanagement, corruption, civil war, or a combination of these factors, monetary policy has failed miserably in each country cited by E&Y. With over 60 recorded hyperinflationary crises in world history, the most famous example is Germany’s Weimar Republic — the name given by historians to the German state from 1918 to 1933.

Weimar Woes

During the first world war, the German government opted to finance the conflict entirely through borrowing, instead of savings and taxation, wagering that it could easily cancel its debts after the Central Powers’ certain victory over allied forces. But Germany’s bet failed. The Central Powers ultimately conceded defeat at the 1919 Treaty of Versailles, which assigned the bulk of liability for the war and its related costs to Germany.

From 1914 through 1919 the price of German goods and services doubled, according to “Paper Money” author George J.W. Goodman. In the immediate years following World War I, the German people suffered severe food shortages. And by 1923, the Weimar economy nearly collapsed, with the exchange rate between the German Mark and the U.S. dollar death-spiraling to a ratio of a trillion-to-one. Today, we see parallels in the Venezuelan crisis, where the South American nation registered 80,000-percent inflation by the end of last year.

How it Begins

Hyperinflation generally begins when a country starts printing disproportionate sums of money to pay for its spending. This bump in money supply inevitably causes prices to rise. Inflation can also jump when the demand for goods and services grossly exceeds supply. This is called demand-pull inflation. The imbalance gets worse when governments, instead of trying to compress money supply, keep printing currency, causing local prices to spike beyond sustainable thresholds.

While several factors like low-interest-rate policies and current account deficits (when import values of goods and services exceed export proceeds) often lead to currency devaluation, high inflation is chief among its precursors. Thus, as inept, sovereign monetary policies lead to local currency devaluation in global foreign-exchange (FX) markets, native holders of devalued funds bear the consequences — their savings become worthless.

Desperate Measures

During currency crises, panicked citizens will often try to counteract devaluation by exchanging their native funds for more stable fiat assets like the US dollar, often resorting to black-market brokers to facilitate conversions. In times of panic, the black market becomes the defacto hub for FX commerce, because repressive governments typically impose strict capital controls that shut down legitimate currency exchangers. The reason governments react this way is to prevent domestic currency sell-offs from further devaluing local fiat in global FX markets.

Even more pernicious, history has shown that elites in crisis-struck nations have frequently exploited preferential access to state channels, procuring dollars at below-market rates, under the guise of purchasing greenback-denominated imports abroad. As highlighted by the recent Venezuelan meltdown, “cheap” dollars are often misappropriated by the well-connected, either deposited into shell company bank accounts or diverted into FX black markets, where they are sold at a premium to the desperate masses.

Modern Cases

In fact, foreign exchange subsidies granted to favored people and industries are largely to blame for the collapse of Venzuela’s bolivar. Former Venezuelan government officials have claimed that their country’s currency control system, which offered preferential FX rates for life-critical industries like food and medicine, enabled the theft of some $300 billion from state coffers over the last decade.

While official Venezuelan government policy was to prioritize industries deemed crucial to the public, the net result was the creation of an unjust two-tier system, leading to skyrocketing dollar FX rates on the black market. This corruption of Venezuelan exchange-rate controls eroded the bolivar’s value in legal markets, driving runaway inflation.

The situation in Venezuela has now become so dire that the United Nations (UN) has deemed it a humanitarian catastrophe. Venezuelan President Nicolas Maduro’s government has bankrupted the once-oil-rich nation, leaving its citizens impoverished and suffering life-threatening shortages of food, water and medicine.

With Venezuelan financial authorities devaluing the bolivar by 95 percent last year, monetary and economic collapse has spawned a migrant crisis, prompting three million refugees to flee the country in search of sustainable living conditions. Meanwhile, similar inflation crises are rapidly escalating in countries like Zimbabwe and Argentina. The former is in the grips of violent protests following a 250-percent hike on fuel prices and the latter is facing record levels of inflation.

How Stablecoins can Help

In 2018, the International Monetary Fund (IMF) identified 11 countries suffering inflation rates of 20 percent or more. With millions of financially displaced people watching helplessly as their wealth evaporates by the day, stablecoins can empower inflation-ravaged populations with the monetary constancy of the developed world.

In distressed economies, stablecoins enable citizens to seamlessly migrate their wealth and savings into asset-backed digital currency accesible on their mobile phones. Circumventing transaction monitoring by local banks, a widely adopted stablecoin ecosystem disables the financial surveillance capabilities of corrupt regimes. With a skillfully deployed stablecoin, people and businesses can transact peer-to-peer, using electronic money with more intrinsic and predictable value than their distressed local currencies.

While this framework is predicated on the foundation of a functional telecommunications infrastructure, December 2018 research from the UN depicts a positive trendline. According to the UN, 51.2 percent of the global population, or 3.9 billion people, had Internet access by the end of 2018, with the majority of connectivity growth being reported in Africa. Internet access in Africa grew from 2.1 percent in 2005 to 24.4 percent last year, according to the UN.

Even more relevant to stablecoin adoption, the UN found that over 90 percent of the world’s population can now access the web through a 3G-or-higher-speed network. With the proper telecom infrastructure in place, stablecoin deployment has become much more feasible, even in the most challenged jurisdictions.

In 2019, the Reserve team is actively working to serve some of the world’s most vulnerable populations. The Reserve protocol will enable people displaced by sovereign currency crises to safely insulate their savings from reckless monetary policy. Protecting people’s money is a critical first step to helping combat poverty in these regions, and in our following posts, we’ll discuss additional issues like enabling people to send money home to their families and enabling businesses in these regions to accept payments in these stable digital currencies.

In the meantime, to learn more about Reserve, please join the conversation on Telegram.