By SCP Fellow Dan Rohde
Cryptocurrencies, like Bitcoin, are caught between two worlds. On the one hand, they fancy themselves “currencies” – promising to be an effective means of payment. On the other hand, cryptocurrencies act as speculative assets – things purchased today with the hope that they will increase in value down the line.
The problem is that these two functions often conflict with one another. And while crypto assets have proven effective speculative assets (indeed, they’ve made some speculators quite a lot of money!), they’ve proven quite bad as a means of payment. Exchanges, and stablecoins, are the primary means by which crypto advocates are attempting to bridge this gap – to move from the world of speculation to a functional means of payment. Sadly, the result leaves much to be desired, and, in my opinion, adds rather little to our existing payment infrastructure.
This hasn’t stopped advocates, like Mike Moffat, from promoting the use of stablecoins as a common currency. His argument is that this new currency could help the cost-of-living crisis and promote economic equality – particularly for young people. I am not convinced that crypto can help address economic inequality. Before we get into that, let’s break down what stablecoins are and aren’t, and how to think critically about their promises.
To be effective, a currency should have at least two things. First, it should be an easy mode of payment. If it’s a pain to use something to buy and sell things, you’ll typically use something else. (For example, the easier debit and credit cards have become to use, the more they displaced cash as a mode of payment.)
Second, it should have a relatively stable nominal value. It’s vitally important to know, when you go purchase a coffee, that the toonie in your pocket will actually buy you that $2 coffee without haggling or negotiation. In other words, the number on your money should generally be what it’s worth in purchases. The more variation you have, the harder it is to use your money as a means of payment.
Cryptocurrencies are generally very bad at both of these: here’s how. Bitcoin, just to take a well-known example, distinguishes itself by saying that it’s a fully anonymous means of peer-to-peer payment that does not require financial intermediaries, like banks or credit card companies. It casts itself as “digital cash” that you can exchange directly with your peers. To accomplish this, it uses elliptic-curve cryptography to anonymously process payments between digital wallets – a process that requires so-called “miners” to expend considerable energy and computing power to validate each transfer. While estimates vary, one study suggested a single bitcoin transfer can require between 100 and 1000 kWh, compared to .001kWh for a credit card purchase. (This means that a single bitcoin purchase can take around 500,000x more energy than a credit card purchase!)
The time involved in processing a crypto payment is also substantial: Bitcoin payments can get confirmed in about 10 minutes, but typically take 1-1.5 hours to complete. Imagine waiting 10 minutes to confirm payment of your coffee. For this reason, bitcoin transactions very often occur over a crypto-exchange. (Imagine a stock exchange, but for crypto assets.) This greatly simplifies the process of moving assets between holders, but it also does away entirely with that idea of bitcoin being anonymous and independent of financial intermediaries.
Cryptocurrencies are also notoriously bad at holding a stable nominal value. Like all speculative assets, their value rises and falls continuously based on available prices on the market. At any given moment, you don’t know exactly how many $2 coffees your bitcoin will buy you. At the time I am writing this, one Bitcoin, or “Btc,” is valued at about $114,000; exactly 4 hours ago, it was just over $112,000; six months ago, it was $75,000. This kind of variability is fine when you’re playing the markets, but it’s terrible for making everyday payments.
Stablecoins were developed to overcome these problems. A stablecoin is a type of crypto asset that, unlike Btc, isn’t anonymous, peer-to-peer or even necessarily protected with any sort of cryptography. Rather, a stablecoin is issued by a private company, and pegged to a regular fiat currency (like the U.S. dollar, or USD). What does it mean that the coin is “pegged” to a regular fiat money? All it means is that the issuer promises their coins can be redeemed at any time for their face value in regular money. So, one USD-pegged coin can be redeemed for $1 in your bank account. Stablecoin issuers maintain this peg by holding a set of liquid financial assets that they can sell off at any time to ensure they have enough money to pay out redemptions. Placing stablecoins on an exchange where they can be easily swapped with crypto assets like bitcoin aids in converting crypto-assets into regular money and helps anchor their nominal value.
If this stablecoin setup sounds vaguely familiar to you, that’s because it is: it’s exactly how your bank works! Your bank issues credits denominated in Canadian dollars, or CAD. They don’t call those credits “coins,” but that doesn’t matter very much. Your bank ensures that the credits they offer (which we call “deposit accounts”) stay pegged to CAD by holding a large, diversified set of liquid financial assets, by subscribing for deposit insurance under the Canadian Deposit Insurance Corporation, or CDIC, and playing a part in Canada’s financial safety net.
However, there is one big difference between your bank and a stablecoin issuer: your bank is tightly regulated under the Office of the Superintendent of Financial Institutions (OSFI) and the Financial Consumer Agency of Canada (FCAC) and can turn to the Bank of Canada in a crisis. In contrast, your local stablecoin issuer is likely trying its best to avoid any and all such regulation as far as it is able. You can hope they are being honest about their assets, but all you really have is hope.
Like many pieces about crypto and stablecoins recently, Moffat’s blog points to many, very real problems with our current financial system. He points out how expensive credit card transactions are for small businesses, and how difficult it can be to transfer money abroad. (Here, for example, is an excellent recent article about credit-card fees.) These are very real problems, ones that particularly affect small business, and that call for real solutions. He also points to a very genuine and important ambiguity as to how stablecoins should be regulated – either under the Federal Government’s power to regulate ‘banks’ or under the provincial power to regulate ‘securities.’
The big question, however, is what crypto actually does to solve these problems.
Moffat says that stablecoins can be programmed/designed to provide cheaper payments and higher rates of interest for young and middle-income savers. He doesn’t specify anywhere exactly how or why they don’t already do this. What type of “programming” is going to make lending to younger or lower-income individuals profitable for stablecoin issuers or crypto lenders when it isn’t for banks? How is it that stablecoin issuers, which adopt much of the model of regulated banks, could offer more “frictionless” payments than the existing payment system? How exactly are stablecoins, which are tied to notoriously volatile crypto markets, going to help younger individuals save safely for a home?
Advocates often wax lyrical on crypto’s potential to usher in economic equality, and they often build their case on very real problems with our financial and payments system. But we should not so easily buy into their myths. While I’m not making any claims about Moffat in particular, advocates are very often (though not always) out to hype their product rather than advocating for real solutions to these problems. We should always ask whether what they are offering actually adds anything of value to be considered.
There are no doubt real problems with our current banking system that contribute to economic exclusion and inequality. As Moffat points out, fees for international remittances are large. Too many Canadians are “underbanked,” denying them access to vital payments and lending infrastructure. Rather than turning to crypto, which was founded on libertarian anti-government ideology, there are other potential solutions to these problems.
Canada could directly regulate credit card fees or international remittances to help consumers, small businesses and people sending money to family abroad. Open banking also provides an avenue to rethink public access to credit. Lastly, but perhaps most importantly, we could (and should) consider developing a public digital currency, such as a Central Bank Digital Currency (CBDC). Why shouldn’t the state, which already provides cash free of charge, provide a public, digital money? A type of debit card that small businesses can accept without paying fees to banks. Wouldn’t that address many of the main issues with our current system without turning to digital libertarians?
At best, stablecoins mimic what our banks already do, only with less transparency and oversight. If we want a payment system that is cheaper, fairer and more inclusive, we should look through the hype to real policy innovations to deliver genuine improvements for Canadian households and businesses.
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