Dollar Dependencies: Stablecoins do not equal economic freedom
In the recent Bankless debate between SBF (just one week before the FTX collapse) and Erik Voorhees on the regulation of crypto and web3, I was surprised that crypto’s dependence on the U.S. dollar was not discussed. The actions of regulators are being constantly scrutinised with shock being expressed within crypto and web3 circles regarding the actions of government agencies such as the U.S. Treasury’s OFAC going after crypto and web3 projects. However, such attention on the web3 community is inevitable when they choose to embrace stablecoins denominated by reserves held in U.S. dollars.
The dollar may be the world’s reserve currency (for now). Still, if projects choose to embrace stablecoins such as USDT and USDC, the U.S. government is unlikely to sit back and watch this ecosystem flourish without taking any action. It is my view that any web3 project that supports transactions using a dollar-backed stablecoin, needs to be prepared to enact AML, FATF, PEP and any other legislation the U.S. government sees fit. The only way to circumvent this is to stick to native cryptocurrencies that have zero exposure to USD.
Stablecoins have become one of the stalwarts of the crypto ecosystem, with the three largest, USDT, USDC and BUSD accounting for over $130bn in market cap of the entire crypto ecosystem trillion dollar market cap. They enable crypto investors to move out of volatile crypto positions into dollars without having to leave the crypto ecosystems and depending on the jurisdiction, avoid capital events on their activities.
They also allow participation in the DeFi ecosystem via DEXs and lending protocols allowing holders to get lower-risk yields due to the underlying price stability of these assets. This convenience and price stability of fully collateralised stablecoins (algorithmically backed stablecoins such as Terra’s failed UST are a different story) are perceived as a crucial component of the web3 ecosystems. But for some reason, they are viewed by many in the community as another crypto asset akin to any other project token or native protocol currency like bitcoin or Ether.
Holding such a view is incredibly naive. Physical dollars are freer than those held in a crypto wallet. The crypto mantra of “not your keys, not your crypto ”, simply does not apply to dollar-backed stablecoins, and it’s easy to see why if you refer to some of the historical actions by Tether and Circle, bowing to pressure by the U.S. government.
- Tether has frozen over $360m in assets
- Circle blacklisted all Ethereum addresses owned by Tornado Cash
The U.S. dollar has flourished during the past hundred years, with over 40% of global trade invoiced in dollars, even though the U.S. share of global trade is roughly 10%. It’s estimated that 75% of $100 bills are held outside of the U.S, and the Federal Reserve has a very profitable business exporting U.S. dollars (its America’s second most valuable export after refined petroleum). This success has also ensured that no other currency has the global financial infrastructure to compete with the dollar.
This reliance on the dollar has extended its utility far beyond trade and enabled the U.S. government to weaponise it. Rather than starting wars with rogue nations, it’s far easier for the government to apply economic sanctions against these nations, crippling their ability to undertake global trade as they are simply shut out of the dollar economy. Any organisations ignoring such sanctions face harsh responses from the U.S. government ensuring that they take such requests very seriously. Thus many financial organisations have a gamut of regulations they have to comply with covering AML/CTF/sanctions.
In the world of tokens and stablecoins that are managed by smart contracts on-chain, it’s straightforward for project teams controlling such assets to enact such restrictions should they be required to. With all activity taking place on-chain, projects can blacklist accounts as we’ve seen happen with the stablecoins mentioned above. In this respect, stablecoins whilst positioned as native web3 assets are really no different to coins being issued on-chain by your bank. Both are being watched closely by the U.S. government; however, one is regulated and the other isn’t. This means that it’s actually far safer to hold dollars in a U.S. bank account than it is to hold stablecoins either in your crypto wallet or on a crypto exchange.
The Federal Deposit Insurance Corporation (FDIC) guarantees dollars in a bank account up to $250,000, it offers no such guarantees to issuers of stablecoins. As the crypto regulatory landscape becomes clearer, it’s highly likely that those dollar deposits in U.S. banks could appear on-chain, much like JP Morgan, MAS and others did recently when they tokenised deposits on Ethereum.
In the future, these types of deposit-backed stablecoins will likely be extended similar guarantees by the FDIC that regular bank deposits are. However, until this is the case, stablecoins are a convenience, but they should not be held in the same regard as other native crypto assets.
Dollars tracked on-chain as stablecoins or tokenised deposits are a far more attractive proposition to the U.S. government than physical dollars, as they can be controlled in a way that physical cash cannot. Hence for any proponents of decentralized currencies, if they must hold dollars, they’d be best off holding physical dollars as opposed to stablecoins.
On reflection, it is strange that decentralized finance includes stablecoins as a key component of them. Whilst stablecoins do provide a convenient mechanism to represent fiat currencies on-chain and engage with DeFi protocols. They are, for the time being, a higher-risk form of fiat money, with many properties that make them more attractive to regulators than cash.
I am not opposed to fiat currencies, but I do find it interesting that stablecoins are not positioned as such, but it would make them sound a lot less interesting if they were simply described as dollar-backed tokens.
It is worth mentioning that stablecoins are a fantastic innovation in developing economies where accessing dollars can be challenging and there is a less stable local currency available. But for much of the developed world, they’re just a fiat currency without government guarantees, which can be controlled by governments in a way that physical cash cannot be due to its on-chain nature.