The Rise Of Decentralized Money On Polkadot

Last month I wrote about the rise of stablecoins – from USDT, with a market cap of $70 billion, and USDC, with a market cap of $32 billion, to government-sponsored digital currencies – most notably, China’s Digital Renminbi and Cambodia’s Bakong. In many ways, this seems to be the era of the “crypto-dollar,” which, like the petrodollar before it, could be yet another funnel for global hyper-dollarization. And because the majority of stablecoins are still backed by fiat, they are hindered by the flaws of the centralized legacy financial system and any U.S. regulatory oversight. USDC, for instance, allows Circle to blacklist accounts if asked to by regulators, which limits the use of the token as fully decentralized collateral.

However, a new wave of algorithmic stablecoins is on the horizon, allowing for a digital and stable unit of account that isn’t shackled by Dollar-backed collateralization. Some promising examples of newly launched projects include OHM by Olympus, FLOAT by Float Protocol, RomeDAO and most recently, XST on SORA, built in the rising Polkadot ecosystem, and integrated into Polkaswap.

Dollar-Based Inflation is a Century-Old Threat

Though the U.S. Dollar has served as the de facto global reserve currency since the Bretton Woods Agreement in 1944, inflation is not a new issue for the Dollar. In 1911, the Dollar faced inflation due to fluctuations in the price of gold. Stoic proponents of gold as a store of value can often ignore its tendency toward volatility and its historic reputation of instability. The Dollar was removed from the Gold Standard both in 1933 by FDR, to help America finance itself out of the Great Depression, and again in 1971 by Richard Nixon, to finance increased spending on the war in Vietnam. 

Today, due in part to increased levels of spending as the economy opens back up post-pandemic, we are witnessing the highest inflation rates in over a decade. Despite the U.S. Treasury Secretary Yellen’s claims that inflation is under control, and the Federal Reserve’s promise of tapering emergency asset purchases, the U.S. Dollar continues to fluctuate, ultimately harming consumers through increased prices paired with stagnant or declining wages.

Stablecoins Are Becoming Integral to the Crypto-Ecosystem

In 1913, American economist Irving Fisher, first proposed a stabilized alternative dollar, observing the then gold-backed Dollar’s lack of stability. Instead of being backed by a fixed weight of gold, with varying purchasing power, Fisher proposed that the Dollar be fixed in purchasing power and pegged to a basket of goods (i.e., an index), effectively stabilizing its value.

Although Fisher’s ideas were not adopted in his time, they paved the way for blockchain-based digital stablecoins. Inherently “stable” by design (that is, pegged to an index or a stable asset), stablecoins are unlike other cryptocurrencies, which fluctuate wildly in value. Bitcoin, for example, can fluctuate 30% to 60% within a single week, depending on market sentiment, regulatory announcements or even an errant tweet from Elon Musk. Stablecoins, on the other hand, are “a blockchain based token that is derivative of another one and which is targeted at holding a stable unit of value.” 

Because money needs to be a store-of-value, in addition to being a unit-of-account and medium-of-exchange, cryptocurrencies are perceived as too speculative to replace money unless their volatility can be dampened or made predictable. By reducing the intense exchange rate fluctuations whilst avoiding the pitfalls of the traditional financial system, stablecoins offer a potential way forward for finance – but only if they are truly decentralized stablecoins.

Algorithmic Stablecoins Promise Innovation Beyond the Dollar

Unlike fiat-backed stablecoins, algorithmic stablecoins hold the promise of collateral diversification, which can create resistance to hyperinflation and financial market instability. Additionally, users of decentralized stablecoins are investing in the value of transparent protocols defined in immutable code, rather than having to put their trust in a central bank, company or government. This empowers users to innovate and compose the future of money, unimpeded by the hold ups of the legacy system. 

The newest addition to the algorithmic stablecoin market, SORA Network’s XST is based on Polkadot technology (Parity Substrate) and is backed by an algorithm that guarantees the token’s value. Synthetic assets derive their value from smart contracts linked to oracles that determine current prices, such as financial instruments and securities, rather than the value of fiat currency. While algorithmic stablecoins, such as MakerDAO’s DAI on Ethereum, or Karura’s kUSD in the Kusama ecosystem, require overcollateralization (up to 180% in the case of kUSD) in order to maintain their value, SORA XST (“XOR SynThetics”) is backed by a smart contract that mints or burns the XOR token, given an exchange rate from a price oracle. This allows XOR holders to convert to XST synthetic tokens without overcollateralization at 1:1, giving a nod to Fisher’s century-old ideas of pegging tokens to an index to maintain the desired value. 

In theory, future algorithmic stablecoins can be pegged to any index of value, not just U.S. Dollars or other fiat currencies. One proposal in the SORA ecosystem is to use an oracle to create an XST token pegged to the Unidad de Fomento, which is an inflation-adjusted price-of-goods index maintained by the Bank of Chile. In the future, other stablecoins could, in theory, maintain their own basket of goods to further decentralize the concept. After all, money is only as useful as what you can buy with it, so having stable purchasing power could greatly improve the store-of-value property of stablecoins.

Stablecoins are Systemically Important

Algorithmic stablecoins provide the benefit of transparency of the internal logic of the tokens and any collateral used for maintaining their value. Just last month, Tether was required to pay a $41 million fine for making “untrue”  statements about its fiat backed reserves. With over $120 billion worth of stablecoins pegged to the U.S. Dollar, they have become a cornerstone of the cryptocurrency markets, making transparency of collateral a pressing issue for both users and regulators.

As more and more new entrants introduce into the market a wide range of varied stablecoin options – from government-backed, to corporate-backed, to decentralized – consumers will have the chance to select from a menu and will be the final decision makers on the question of what is viewed as ‘sound money.’ Stablecoins, serve a real and underserviced human need. So much so, in fact, that even a century ago economists were discussing many of the same concepts finally being implemented today. Given the continued volatility of cryptocurrencies like Bitcoin, stablecoins don’t seem likely to go away, but rather, new innovation in this field will continue to bring forth new and exciting opportunities for the future of money.