Outlier Ventures Weekly Brief Issue #22 View Online

Unstable Tokens

The token market has had its share of attempts at issuing stable tokens and seeing them slide from the desired price. As covered in our past issues, they could be backed with dollars, commodities (including tokens) or issued algorithmically. However, the conditions the markets are in today make it difficult for any of them to maintain a stable peg of $1. The New York Attorney General’s on-going investigation against Bitfinex has caused concerns around Tether’s ability to maintain its dollar value. This has led to a discount for USDT as presumably traders swap the token for other, stable options like USDC that are backed with publicly verifiable audits. In this week’s issue, we take a look at the predicament “stable tokens” have found themselves in.

Image: Stable-token price chart from TokenAnalyst. 

Tethered to an investigation
New York’s Attorney General recently released a legal filing suggesting that prominent exchange Bitfinex has been relying on Tether’s dollar reserves to cover up for missing funds. USDT’s stability comes from exchanges offering trading pairs against it and claims that each dollar issued on the blockchain is backed by the dollar equivalent in cash or other forms. If these reserves are indeed depleted, then the dollar peg no longer stands. Markets reacted almost instantaneously sending USDT price from $1.01 to a low of $0.985 over the course of the day. Bitfinex has responded to the NYAG’s actions in a formal statement suggesting over $850 million reported to be lost has actually been seized and safeguarded and that they are in the process of recovering it. No exchanges have hinted at de-listing USDT yet. 

On some days, centralisation comes at a premium
Tokens like TrueUSD, Paxos, and USDC saw premiums averaging 2.49% over the course of the day. According to The Block, the highest premium recorded on these exchange backed tokens was 4%. As USDT finds itself in a legal quagmire and DAI fails to hold its peg, exchange issued stable currencies, backed by auditable trails of dollars tend to see more traction. Albeit centralised, they seem to be seeing the highest levels of confidence from the average trader. According to exchange data provider TokenAnalyst, on-chain activity for the day on USDC (Circle's stable token) is up 6 times while that of PAX (Paxos standard) is up 4 times. Capital migration from one-stable token to another seems eerily similar to those of capital flights from one currency to another.

The Dai-lemma of our times

While dollar backed tokens fight and win their own battles, DAI struggles to maintain its $1 price. The token is issued as an over-collateralised loan backed by Ethereum. Each time there is an excess supply of DAI in the market, its price falls below $1. In order to limit DAI issuance, MakerDAO holders routinely vote on an increase or reduction of lending rates - referred to as stability fee on the network. What started at 0.5% initially is now at 14% and will likely increase to 16.5%. The rising stability fee has indeed resulted in a reduction on DAI issuance but as fees go higher, and the peg fails to hold, it is likely that the market chooses other alternatives. On one end, the community faces the tough choice of raising stability fees to ensure the peg holds, and on the other come the challenges in retaining community while the terms on which the product is built keep changing. For more on DAI we recommend their brilliantly maintained GitHub. 

A stable, digital currency would be the foundation upon which many internet-first applications could be built in the future. We are seeing some early trends towards this with decentralised financial applications like lending. However, in the absence of a reliable option, the markets will continue to pay premiums and sell at discounts as fear-induced selling and buying take place. What we are witnessing with stable tokens, is a repetition of what has happened historically with currencies. Except this time, it is all verifiable on a public blockchain! That's progress. 

Anyone in the world can check how much collateral backs Dai at any time
You don’t need to trust a bank
You don’t need to trust an auditor
You don’t need to trust the media
You verify it yourself
This is why open finance is transformational
Outlier Venture's Token Engineering team won the New Frontier in Enterprise Research Award at Blockchain Revolution Global 2019
Congrats to Eden Dhaliwal, Anesu Machoko and Geoff LeFevre
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