#xx Beyond Citations | Stablecoins, intermediation and the global financial landscape
Examining what excites Trump but threatens SWIFT, Mastercard and Visa.
Trump doesn’t hide his interest and passion for cryptocurrencies. As a presidential candidate, he backed cryptocurrencies, and kept true to his promise after assuming power. But Trump is not just promoting cryptos, he is also venturing into this business via his family-linked World Liberty Financial (WLF). What does WLF’s website say?
USD1 is redeemable 1:1 for U.S. dollars. USD1 is backed by dollars and U.S. treasuries that have the full faith and credit of the U.S. government.
Claiming to be inspired by Trump, the WLF does some legal gymnastics in explaining their association with the US president:
BitGo and entities affiliated with World Liberty Financial, Inc. are entitled to interest earned on the reserve assets backing USD1 pursuant to agreements between these entities. DT Marks SC LLC, an entity affiliated with Donald J. Trump and certain of his family members, has an indirect economic interest through majority equity ownership in an affiliate of World Liberty Financial Inc. which is entitled to interest earned on the reserve assets backing USD1 held or maintained by BitGo. Any references to or quotes or imagery attributed to or associated with Donald J. Trump or his family members should not be construed as an endorsement or representation or warranty with respect to any product or service offering. USD1 is being offered by BitGo and World Liberty Financial, Inc., and their respective affiliates. USD1 is not political or associated with any political campaign. (emphasis added)
Trump’s association with the crypto world and some reported deals have raised questions about corruption, bribery and conflict of interest.
Even as Trump rides the crypto wave, Mastercard, Visa and SWIFT executives are having a tough time. But not all cryptocurrencies are concerned. Extreme volatility displayed by some of the most popular cryptos like Bitcoin also limit their allure to masses. But stablecoins take care of this volatility to some extent by pegging their coins to actual feat currencies. While crypto stocks are surging, ‘[s]hares of Visa and Mastercard, by contrast, are on track for their worst monthly performance in a couple of years.’
But what are these stablecoins? How did they emerge? What do they mean for intermediation in the global financial landscape? Catalini et al. have some insights in their following 2022 paper:
Catalini, C., de Gortari, A., & Shah, N. (2022). Some simple economics of stablecoins. Annual Review of Financial Economics, 14(1), 117-135. https://doi.org/10.1146/annurev-financial-111621-101151 (open access)
Catalini et al. look at the financial architecture and the role of cryptos/stablecoins through the prism of intermediation. It is because of properties such as reduction in cost of verifying transactions and existence of distributed governance, cryptos ‘replace some of the functions of traditional intermediaries with a combination of cryptography and incentives.’ But as discussed above, despite all their advantages, cryptos suffer from a fundamental problem — volatility. Stablecoins attempt to solve for this volatility by placing themselves more towards some form of intermediation in the intermediation-disintermediation spectrum. If cryptocurrencies like Bitcoin are towards the disintermediation extreme, the stablecoins are closer to the traditional intermediation-heavy currencies.
According to Catalini et al. ‘[s]tablecoin issuers have two key levers to protect stability: (a) the choice of reserve assets and (b) the design of the stabilization mechanism used to keep the coin price pegged to the reference asset.’ Stablecoins can either be of highly centralised kind (that back coins 1:1 with a reserve currency such as central bank issues cryptos) or of decentralised kind (that perform algorithmic functions to keep price on par with reference assets). The authors brilliantly explain the algorithmic stablecoins:
These stablecoins are not backed by external assets and rely on their own equity to deliver some degree of stability. In particular, they typically regulate coin supply through two sets of coins: the stablecoin and an investment coin (also called “seigniorage” or “dual” coin) targeted at absorbing market volatility. At a high level, their stabilization mechanism inflates the outstanding supply of stablecoins in exchange for investment coins when prices are above par and deflates it when they are below par. When the price is below par, the protocol issues more investment coins and uses the proceeds to repurchase stablecoins and remove them from circulation, raising the price. Thus, the investment coins function as equity, bearing the risk of dilution when coins trade below par, but enjoying additional returns in periods of growth. To ensure investment coins have some intrinsic value, they are often imbued with additional functionality; e.g., they are required for paying transaction fees.
But irrespective of whether it is a stablecoin with reserve asset backing or purely algorithms at play, the role of the platform or the stablecoin issuer is an important one and leads to greater intermediation as compared to Bitcoin and other volatile cryptos. The latter, by their very design, work on decentralised decision making.