Stephen McKeon is a leading expert in crypto-assets, including tokenized securities. He is academic director for the University of Oregon’s Cameron Center for Finance in Eugene and a partner at the Collaborative Fund, a venture capital and private equity firm in San Francisco. This interview, about the uses and abuses of stablecoins, has been lightly edited and condensed.
Since early fall 2018, the number stablecoins has proliferated. What is driving that?
There are a variety of stablecoins. On one far-end are fully algorithmic stablecoins like Basis. They shut down late last year. Then there are stablecoins that are collateral backed with crypto-assets. So, Maker and [their stablecoin] Dai would be an example of that protocol. And then you have fiat-backed stablecoins, which as you say are really proliferating. [Such coins are backed by fiat currencies such as the dollar and generally a single coin represents a single unit of the currency.] We’ve got the Gemini dollar. We’ve got the True USD [for U.S. dollar]. We’ve got USDC from Circle and Coinbase, plus PAX and others.
They proliferated really because of Tether. It has been the market leader, in terms of fiat-backed stablecoins, with a couple of billion dollars of assets issued. They were the first to launch [in early 2015], which is why they grew so large. But they didn’t do a great job of instilling trust among the community. And so, there were questions whether the fiat really existed in a bank account [to back each coin]. The audits weren’t as frequent and thorough as some market participants might have liked. And yet a tremendous amount of assets were passing through their platform. They were [part of] a trading pair on many of the exchanges.
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The community saw an opportunity to create similar products with more accountability. The first one [to compete with Tether] was True USD by TrustToken, which is based out of San Francisco. And they were immediately picked up by a variety of exchanges as a Tether alternative.
How is TrueUSD different from Tether?
The legal entity they use is a trust. There’s a long legal history and precedent around trusts, that they have to act as fiduciaries. They tried to replicate something that was similar to Tether except with more transparency. Then some of the financial institutions in the space saw an opportunity because it’s not that difficult to start one of these things, right?
If the dollars are in a bank account, particularly a U.S. bank account, the concern has always been they are subject to seizure or subject to a freeze.
You need to get a bank that’s willing to hold the assets and you start issuing tokens. These are primarily Ethereum-based products—smart contracts or tokens on top of Ethereum. Then you need to set up a process for redemption. But, of course a company like Gemini or Circle or Coinbase are already set up as fiat on- and off-ramps. They’re well positioned to create those types of products.
Gemini and PAX are both trusts regulated by New York’s banking regulator. What do you think of that model?
There are pros and cons to the regulated model. The pros are that it gives market participants more faith. These are regulated by the New York State Department of Financial Services, which is one of the most stringent regulators. That instills confidence. The drawback is that, to be really compliant with regulations, they have build into the smart contract a feature for law enforcement to seize assets. That has given certain portions of the community some concern. It’s really inconsistent with the ethos of bitcoin and other cryptocurrencies. Seizure proofing is part of the value proposition for bitcoin and other unregulated cryptocurrencies.
Are some stablecoins seizure proof?
You would look to the more decentralized version of a stablecoin like Dai. I suspect Dai is more seizure proof than the fiat-backed versions. If the dollars are in a bank account, particularly a U.S. bank account, the concern has always been they are subject to seizure or subject to a freeze.
USDC, True USD, Gemini, and PAX are among the top five stablecoins in market cap and they all have high trading volumes. Why are they ahead?
All of those are getting traction. We’ve seen billions of dollars of transactions. A lot of that [is due to the fact that] those are found in trading pairs on many of the exchanges. Major exchanges have listed them and created trading pairs around them. I think most of the trading exchanges at this point have listed at least one of the [top] fiat-backed stablecoins. Many of them are listing multiple fiat-backed stablecoins. That they are not seizure proof is not dissuading many market participants.
Will all stablecoins, including Tether, be regulated, or will they be more in tune with some of the concerns of the crypto community about potential asset seizures?
I think any fiat-backed stablecoin is probably going to need to be regulated, including Tether. Even if it weren’t regulated, if the dollars are held in a U.S. financial institution. And, frankly, outside the U.S. in Europe and places where authorities could get at the funds, you’re always going to have this issue of potentially being frozen or seized. With the decentralized model you don’t have that issue. It’s much more difficult to seize or to freeze bitcoin. We know that in Silk Road those bitcoins were seized by authorities and auctioned off. But they have to compel the owner to provide the private keys.
Why do we need stablecoins?
Where there’s a time delay between the moment of contracting and the moment of payment, where the participants don’t want to take currency risk, stablecoins make sense. Prediction markets need stablecoins. Distributions from traditional asset tokens are going to need stablecoins. I don’t know that they address all use cases but there are definitely going to be use cases for stablecoins.
Where there’s a time delay between the moment of contracting and the moment of payment, where the participants don’t want to take currency risk, stablecoins make sense.
Could stablecoins like the new JPM Coin, which is used to transfer funds more efficiently, affect payment systems?
I’ve not looked into JPMorgan enough to comment on it. I can tell you that a lot of people are concerned. But it’s a permissioned system. [You can only use the JPM Coin if you are a JPMorgan client and have been approved]. That’s quite different from the stablecoins we’ve been discussing so far [which are public]. But I think you’re going to see lots of financial institutions issuing these things.
What are the benefits for them?
You could think about it like this: say Gemini has several hundred million dollars of tokens outstanding which means several hundred million dollars in a bank. You might be able to earn some interest rate on that capital and that’s effectively revenue for the stablecoin project.
I asked the CEO of one of the leading stablecoins how they made money. He said their profit came from interest they earned on the money they hold. That business model most likely applies to many of these others as well.
Yes. You’re creating a token on which you don’t pay interest and you’re getting a dollar on which you can earn interest. You’re earning the spread [between the interest rate you earn on your cash and the interest rate you pay holders of your coins, which is zero.]