How stablecoins could fail
Welcome to Cautious Optimism, a newsletter on tech, business, and power.
Happy Tuesday, friends. The world is watching the Iran-Israel situation, which involved a host of all-caps tweets from POTUS, and even some off-the-cuff profanity. The question is whether or not a ceasefire can or will hold. Meanwhile in Ukraine, Russia is still pounding Ukrainian civilians, and the death toll in Gaza continues to rise. Stocks around the world mostly rose today, while oil fell further. From $75 per barrel earlier this week, oil now costs around $65. For the inflation-cautious, that’s good news.
Today’s newsletter wound up being stablecoin-focused. There are other goodies, but we’ll broaden our topic remit tomorrow to ensure that we’re all having a fun. — Alex
📈 Trending Up: The Hubble Network … ME airspace … housing in Montana, Oregon … whatever this is … Amazon spend in the United States, United Kingdom … Meta-Microsoft? … non-surprises … Waymo in Atlanta … applied AI … Eventual …
Datacenter buildouts: It’s easy to read headlines and go ‘sure, another gigawatt facility, neat.’ But when you consider just how big these installations are, you might sit back a little.
📉 Trending Down: Understanding how AI models really work … NATO … working at Microsoft … everything’s computer … doctor busywork …
Quick Hits
Microsoft should just buy OpenAI: Bloomberg reports that Microsoft is having a somewhat tough time besting OpenAI when selling to AI tools to major corporations. Microsoft is selling lots of AI, to be clear, but OpenAI’s ChatGPT brand is insanely strong. I think the best way to solve the OpenAI corporate structure mess is to simply GitHub the whole company in a single gulp. Think of the synergies! Microsoft could lay off even more people!
A (mostly) legal win for Anthropic: In a judgement out today from the District Court of Northern California, Anthropic mostly won summary judgement against several authors who felt that the company had unfairly ingested their works for its use without paying for them. Anthropic argued that its use of the books was, in fact, fair use. The court found that legally purchased copies of books then used to train LLMs were covered by fair use rules, but that “ downloaded pirated copies used to build a central library were not justified by a fair use.” The ruling could set up a world in which AI companies that trained off pirated datasets — like LibGen — could be in some trouble. But, this is a single ruling; there’s still a lot more legal work to do to sort out IP and fair use in the AI era.
Snowcap wants chilly compute: It turns out that if you chill computing systems down to temperatures so abysmal that even Chicagoans begin to shiver, it can become more efficient in power consumption terms thanks to something called superconduction. Snowcap, which just raised $23 million, wants to do just that. Very cool, and a startup to watch.
Polymarket the unicorn? The Information reports that predictions market Polymarket is close to raising $200 million at a $1 billion valuation. This is slightly surprising given Polymarket’s daily active trader count is falling per Dune data, but underscores how bullish the investing class is on predictions markets more generally. Why? Because investors are accustomed to being in the know, like to wager, and are often skeptical of conventional wisdom. The middle of those three circles is betting on what will happen.
How stablecoins could fail
The Bank for International Settlements — what Reuters calls the central bankers’ central bank — has an interesting paper out that argues for the tokenization of the financial system. The same document argues that stablecoins have material issues that are worthy of pause.
Usually when we see someone argue for something crypto-related today, they tend to also favor everything crypto-related. The splitscreen from the BIS is curious. Let’s figure out what it’s saying.
Here’s how the BIS defines tokenization, detailing potential benefits at the same time:
[Tokenization is] the process of recording claims on real or financial assets that exist on a traditional ledger onto a programmable platform [which is] the next logical progression in the evolution of the monetary and financial system, as it enables the integration of messaging, reconciliation and asset transfer into a single, seamless operation.
In the view of the BIS, tokenization could “knit together operations encompassing money and other assets that would reside on the same programmable platform.” That sounds pretty neat.
Notable in the BIS argument is that it views the current financial system as sound in terms of its overall setup — central banking interacting with with private banks, private banks interacting with business and the public — but in need of a tune-up. To that end, the BIS thinks that applying new technologies like tokenization with healthy doses of anti-fraud and anti-money laundering could be a great way to take something that works today and make it better:
The next-generation monetary system with central bank reserves at the core promises to deliver far-reaching benefits. A key step towards this transformation is the trilogy of tokenised central bank reserves, tokenised commercial bank money and tokenised government bonds, all residing on a unified ledger. Together, these elements could form the foundation of a vibrant tokenised financial system, unlocking new efficiencies and capabilities. Tokenised central bank reserves provide a stable and trusted settlement asset for wholesale transactions in a tokenised ecosystem, ensuring the singleness of money. They could also enable monetary policy implementation on a tokenised platform. Tokenised commercial bank money could build on the proven two-tier system, offering new functionalities while preserving trust and stability. Tokenised government bonds, as the cornerstone of financial markets, could enhance liquidity and support various financial transactions, from collateral management to monetary policy operations.
Honestly the BIS is more technology-friendly than I might have guessed. So, what’s this tokenization-friendly entity’s problems with stablecoins? In its view, “stablecoins perform poorly when assessed against the three tests for serving as the mainstay of the monetary system.” Those tests are:
Singleness: That every dollar (or other currency) can “be issued by different banks and accepted by all without hesitation.”
Elasticity: The ability to scale liquidity up to “flexibly […] meet the need for large-value payments in the economy, so that obligations are discharged in a timely way without gridlock taking over.”
Integrity: The safety of “the monetary system against illicit activity .”
The third test is one that we’re all familiar with, and I think it’s not incorrect to say that KYC/AML rules in the crypto world could use a little tune up. The elasticity point is currently unsolvable by existing stablecoins, as they are only generated when a user purchases one, with fiat provided going into a reserves bucket. You don’t want stablecoins issued sans backing, as they are not issued in the same way that traditional currency is; you don’t spend that much time when buying lunch worrying about the money supply, but if Circle prints USDC tokens sans backing, you would fret. This is a feature of stablecoins from the perspective of current holders, but also means that systems that use stablecoins for a large portion of their economic activity could see banking flows get sticky at times.
The singleness test, however, is worth our time. Here’s the BIS on the issues stablecoins have thereof:
Stablecoins also fare poorly on singleness. [As] digital bearer instruments, they lack the settlement function provided by the central bank. Stablecoin holdings are tagged with the name of the issuer, much like private banknotes circulating in the 19th century Free Banking era in the United States. As such, stablecoins often trade at varying exchange rates, undermining singleness.
Why is that a big deal? The BIS explains:
In this light, when a payee receives a stablecoin as payment, it is the liability of a particular stablecoin issuer. In other words, she checks her phone and sees she has received 10 “red dollars”, which add to her balances of, say, 10 “blue dollars” and 10 “white dollars”. The issuers of these various dollars will differ, and the payee will hold bilateral claims against each one only by accepting payment. Moreover, in the background, there is no settlement on the central bank balance sheet. Therefore, singleness cannot be guaranteed: red dollars might trade at a discount or premium to blue or white dollars, depending on the relative creditworthiness of their issuers.
You can translate this into, say, a theoretical Amazon stablecoin (AMZNUSD) and a theoretical Gamestop stablecoin (GMEUSD). Let’s say you have $100 in AMZNUSD and $100 worth of GMEUSD, but due to investor concerns about the health of GameStop’s business and its ability to provide strong backing to its stablecoin, the latter trades at a discount to the former.
Now expand the scenario to include ten different corporate-introduced stablecoins; do they all trade precisely at their peg? No, they do not; we can see that in the historical charts of stablecoin performance. Thus, the more stablecoins that enter the market, and the more often they are used, the greater the chance that they create not a single unified ‘dollar’ -- or Euro, etc — account, but instead an basket full of non-interchangable quasi-dollars, each tied closely enough to a single corporate entity of varying health or trust that they become non-fungible.
This is why the BIS bangs on about the singleness test. You really don’t want to have to check your wallet for ‘white,’ ‘blue,’ or ‘red’ dollars; you just want dollars.
Amanda Fischer, former SEC CoS, is worried that corporate-backed stablecoins could be used as financial gates, forcing users to stay within their confines or face unique fees; a sort of stablecoin corporate feudalism, in which the local baron is Andy Jassy asking for a few bips for the the hard work he does of earning interest off your deposits. Piss off, theoretical Jassy.
None of the above, I think, will slow the adoption of stablecoins in markets where local currencies are volatile, depreciating, or not accepted by other markets or merchants. Nor will it slow the United States’ push into the stablecoin market. But the BIS’s warning is good reminder that as we reinvent money, even when the new creation is supposed to ape the original instrument, we’re not making a perfect copy. And when we consider how much money moves around the world every moment of every day, small discrepancies can generate big disconnects. And in the financial world when you’re hunting, say, the stability of the dollar, dislocation can be downright terrifying.
Circle shares have fallen around 4% today, but remain about 8x as valuable today as they were at the time of their IPO. With an anticipated rate cut coming as soon as July, Circle backers are wagering that the supply of USDC grows far more quickly than the rate at which Circle can rip value out of its fiat holdings will decline in an era of cheaper money.
Elsewhere in crypto-land: Hut8 announced an “amended and expanded Bitcoin-backed credit facility” with Coinbase that will add “$65 million in incremental, non-dilutive capital that positions us to deploy capital against near-term opportunities advancing through our growth pipeline.” That’s hardly a risk-off posture, I think.