Do you really understand stablecoins?

This article comes from the WeChat public account Laoyapi (id: laoyapi).

Stablecoins "have legitimacy" because they avoid the so-called main flaw of cryptocurrencies: their high price volatility. But whose stability is stable? What is the criterion for "stable"?

This article discusses the traditional understanding of currency "stability" and hopes that everyone will reconsider the significance of its role as a stable currency.

At the start of the third decade of the 21st century, it was clear that the traditional conception of the fiat currency system, centered on the role of the state, was not working. No economic commentator had yet declared that traditional state monetary policy, centered on the interest rate of the U.S. central bank, was losing its influence as a lever for managing inflation and the level of economic activity.

Their recommendations for new policy directions may differ, but we are in a period where business-as-usual policies are no longer working.

To boost economic growth, "official" interest rates have been cut so frequently that they are negative. Borrowers are effectively paying to borrow, while savers are paying for the privilege of parking those savings in a bank. According to data collected by ICE (the Intercontinental Exchange, which owns the New York Stock Exchange, LIBOR, and a host of other world financial indices, markets, and clearing houses), $14 trillion of bonds around the world now trade at negative yields; 80% of these are government bonds.

Secondly, at the same time that the government proclaims the need for austerity for the population, it continues to be ready to pump liquidity into financial markets. Here, the focus on "neoliberalism" is too easily dismissed as the ideological choice of the state, but, with the current functioning of capital markets, it is clear that the profitability of financial institutions must be guaranteed. The 2007-2008 financial crisis did not show the weakness of financial capital, but how its need for profitability will determine what policy agenda the state will implement. "Austerity" is less about paying for bank bailouts than about demonstrating to the financial community and the general population that the power of financial capital is absolute.

Third, and closely related, central banks bought financial assets in the years following the global financial crisis (quantitative easing), promising to put those assets back on the market when conditions "normalized." Now they can't release those assets for fear that asset prices would collapse. The U.S. Federal Reserve began "normalization" in October 2017 -- selling $50 million of Treasury bonds and mortgage-backed securities each month.

The effect is that central banks in the core countries (particularly the US, UK, Europe and Japan) now face the next economic crisis with massively inflated balance sheets and no new strategy for dealing with the crisis other than buying more assets to drive up asset prices. They are so committed to guaranteeing liquidity in financial markets that they can do little else. This makes central banks hostage to financial institutions, which create illiquidity either through "distortions" of market processes - as in the repo market crisis of mid-2019 - or through deliberate misrepresentation of risk, as happened in 2007.

Fourth, the world’s “base” rates (the overnight rates that are considered risk-free) are not working. In the US, the repo market suddenly suffered from illiquidity in late 2019, requiring a massive injection of liquidity from the Fed. LIBOR (the overnight interbank rate quoted in London), supposedly the most important number in the world, was found to be corrupt (manipulated) by participating banks, leading to legal prosecutions and requiring regulatory intervention to rebuild the management and reputation of LIBOR. By 2021, LIBOR will be abandoned, not because of corruption (which has been effectively remedied), but because the market does not focus on borrowing rates as a core, as borrowing itself is not a critical process in short-term markets. Financial valuations are more based on overnight derivative prices, and the trading spreads of these derivatives are based on borrowing rates. LIBOR will soon be replaced by a derivatives index. These derivatives-based indices are already being adopted to determine fixed/floating rate spreads in bond and swap markets: the US Fed has the Secured Overnight Funding Rate; the Bank of England has the Sterling Overnight Index Average, the ECB has the Euro Short Rate, and so on.

First, central banks are not in control of the monetary system: their stated agenda is to generate stability, but their ability to provide stability is being reduced to bailing out financial institutions with liquidity difficulties.

Second, the core change is that big finance is no longer centered around borrowing (debt). Of course, borrowing to generate spreads is a necessary part of finance, but it is not the place for huge transactions. Trading is around volatility, and debt is just a trigger for volatility. Debt is a long position, but the profits come more from positioning for the future. It is the default rate of the loan rather than the interest payment itself that provides the most innovative short-term positions and the problems generated by volatility from the unknowable future.

The two points - central banks' efforts to ensure financial stability and financial institutions' profiting from volatility - are not contradictory. In markets bred by volatility, central banks' stated goal of ensuring stability provides a "fixed position" against which volatility traders can operate. Central bank policy is both fodder and a lifeline for markets when volatility reaches outside of expected ranges.

So what is the future of the world's major fiat currencies? Will they die? We must ask about their assumed inherent stability. What happens when there is a large body of opinion that the value of US Treasuries is unpredictable, and that the Fed's 'assets' are worth much less than they claim? What happens when we have a prolonged period of negative interest rates: there are no 'safe' ways to save, and negative yields become the norm? Fiat currencies require people to 'believe'; so what happens when people begin to doubt? From our current vantage point, we don't have to declare a 'crisis', but we can certainly speculate on a trend towards financial insecurity and mass fear.

It is in this context - the state's ability to create stability has outstripped policy capacity, and financial institutions are relishing the state's inability to provide stability to anyone but themselves.

Cryptocurrencies and new forms of cryptoeconomic organization have found their roles.

Cryptocurrencies are often accused of being "unstable", which provides a new framework for "stability". The question they bring up is: "What is stable? Stable to what?" Of course, if the benchmark is the country's fiat currency, then it is true that any cryptocurrency is unstable. But what happens if we focus on the underlying factors that make a country's currency considered "unstable" based on its own historical precedent? Who decides what is 'stable' and in whose interests do they decide?

Perhaps we need to rethink the role of "stablecoins" from this perspective: stability relative to fiat (or a basket of fiat currencies) is a perception of stability, but it embeds the primacy of fiat over cryptocurrencies and leaves the stability of fiat unquestioned. In this context, stablecoins are considered acceptable cryptocurrencies because they are crypto versions of fiat: but when you want to dispute fiat, when you want to oppose fiat by betting against it (shorting it) and find new stablecoins from a different set of economic and social relations, you will find that money is a social relationship.

We believe the latter is the true social potential of the crypto economy. It provides an opportunity to rethink the social role of money, and the social incentives embedded in fiat money - money as a set of (protocols) of social relations. If and when fiat money faces its next crisis in the future, we hope that everyone will already know what the new stability is - new social relations, processes and goals and new measures of stability that we believe should be constant.

We should ask every aspiring cryptocurrency: what is the concept of stability across time and space that it claims to ensure?