Stablecoins: The Free Market as Ultimate Decentralizing Force
By: Carlos Tapang
Tags: Stablecoin, Free Market, Market, Bitcoin

In this article I am going to propose the following:

Most stablecoin projects like basis.io, carbon.money, and fragments look at decentralization only within the context of their respective, isolated network; I propose that decentralization can also be achieved by the market as a whole because of competition (looking at it at the macro level). Competition is at the heart of Bitcoin security in the form of proof-of-work mining: by competing for rewards, miners are the linchpin of Bitcoin security. However, this mining competition is part of the same network (“network” here is used in the sense of “network effect”). I propose that inter-network competition can work as a decentralizing effect in the case of stablecoins.

Having more stablecoin projects is therefore good.

First, a few definitions:

Stablecoins are a class of cryptocurrencies that are designed to have stable value in time. The Quantity Theory of Money as a formula seems to suggest that price levels with respect to a stablecoin can be controlled through an algorithm.

Price level means the price of a basket of goods in the market, expressed in stablecoin units. In monetary economics, the price level is always a time-relative measure, and stability is defined as price level P1 at t1 being almost equal to P2 at t2, with negligible variance.

Free Market means a market that has minimal government controls. It does not mean the absence of rules, and it does not mean the total absence of government. Government is necessary to protect property rights and to enforce contracts. Most cryptocurrency intellectuals believe that smart contracts are self-enforceable, and that is true; however, not all human activity can be specified in smart contract code. Government is therefore necessary.

Problem and Solutions

The fundamental problem of decentralization in stablecoins is that the price level of goods with respect to a stablecoin is external data that cannot be available to a price-stabilization algorithm. In other words, one cannot write a program with price level as input because this input is available only from outside the blockchain, and this data can only be obtained in a centralized manner.

We can collect the price level data in an automated way, and add it to transaction data in the blockchain. Every transaction data would then contain not just the source address, destination address, and amount; but also a name for a commodity (say “rice”) and location (where the transaction occurred). We can account for the fact that there are different strains of rice (there is cheap rice, and expensive rice). There is no universal standard for classification and naming of the different kinds of rice, but this is a separate issue.

Why is location important? Comparison of price levels should only be with respect to time: we want to remove the effects of product quality and transaction location. Transaction location is important because water, for example, can have a different price in a desert compared to its price near a river. However, location may not be relevant also, like in the case of the source location being different from the destination location (a remote transaction).

Catastrophic events can also introduce errors in the price level. For example, a typhoon in South-East Asia can drastically affect price levels in an island in the Philippines. We want to minimize this effect because it is temporary. (Incidentally, the usual way for governments to reduce “price gouging” in a disaster area is by controlling the price, which has a very deleterious effect in the market in the affected area. Instead, if we allowed prices to increase in the affected area, competing stablecoin companies would see this as a great opportunity and would send their stablecoin money to the disaster victims. The goods in high demand would then naturally get to the disaster area, even without government and other help.)

All of these data problems can be resolved, but the fundamental problem remains: these additional data can be manipulated and may not be accurate. These data are not essential in confirming transactions, and are therefore optional. Being optional means being open to manipulation.

Several other proposals have been made to make this price level data available to an algorithm in a decentralized manner. Buterin has proposed using Schelling points for incentivized external input, and Robert Sams has proposed that maybe a limited view of the price level from within the blockchain (like transaction cost) would be enough to extrapolate from. These solutions have their respective issues.

Free Market Competition

Rather than use incentives at the point of data entry of the price level (as in Buterin’s SchellingCoin proposal), why not simply allow incentives for those who start and maintain a stablecoin? Each stablecoin can then use varying algorithms and means to achieve stability; and the more stable your stablecoin is, the more market you gain. The resulting overall macro-economic system would then be decentralized, because of competition. What if two stablecoin companies merge, wouldn’t that tend to centralize things? Two stablecoin companies may want to merge, but it may not make sense. It would be like merging the ecosystems of Sony’s PlayStation and Microsoft’s Xbox. The network effect here is product-specific and not amenable to merging.

Free market competition as a decentralizing effect also promises to fix the perennial problem of boom and bust cycles, which has been a characteristic of every fiat regime.

How?

There are monetary economists (see George Selgin, for example) who theorize that central banks are one primary cause of boom and bust cycles. According to this theory, boom and bust cycles did not occur prior to the existence of central banks. Central banks, being a monopoly in their respective markets, are indeed “central” and are not in competition with any other business entity. They almost always claim to be independent of the government that hosts them, but a central bank is an ideal arrangement for politicians: it’s easy enough to extract money from the central bank without directly taxing the people; plus if something goes wrong, the politician (and the central bank) can always blame somebody else. Central planning is the key activity of central banks — because central banking is basically a socialist arrangement in the midst of a capitalist system. Boom and bust cycles occur because there is only one currency to absorb the shock of economic storms.

With a free market of stablecoins, money becomes heterogeneous and decentralized. There is not one kind of money but several currencies, competing with each other, like bank notes of old, prior to the existence of central banks. People can exchange a stablecoin for another. People can compare prices in different currencies. Some stores will be equipped to accept any stablecoin, but some will accept only one. People can accept their salary in any one stablecoin, but can easily convert to another to go shopping. More importantly, when an economic storm occurs, a stablecoin company or two may not survive, but damage would be limited and the people would be fine. The surviving stablecoin companies would compete for users of the stablecoin that failed, and those users would pick the best deal they can get. Boom and bust cycles would become a thing of the past.

If you agree with the premise, please clap.

About myself

I started Pure Money Technology last year. We are a startup with no capital as yet, but we retain ambitions to introduce our own stablecoin. We believe that, before a stablecoin company can talk about stability, it first has to establish its stablecoin. Current projects like Basis, Carbon, and Fragments have elaborate mechanisms for keeping the value of their stablecoin very stable; but without a market, none of these mechanisms would work. It’s like putting the cart before the horse. We believe that there should be a different stability mechanism for each stage of a stablecoin’s growth. Only a central bank can have a ready, huge market from the get go (like the ECB for the Euro), but stablecoins have to start from a non-existent market.