Today’s episode is from a 2018 conversation with Stephen McKeon, professor of finance at the University of Oregon and partner at Collaborative Fund. We discuss use cases for stablecoins and Stephen’s view that they represent the clearest path to mass cryptocurrency adoption. For the full conversation, check out Flippening episode 19.
Links Relevant To This Episode
- Nomics on Twitter
- Clay Collins
- Nomics API
- Stephen McKeon
- Collaborative Fund
- Bitcoin (BTC)
- Ethereum (ETH)
- TrueUSD (TUSD)
- Maker (MKR)
Clay: Welcome to Daily Wisdom from the Flippening Podcast. These episodes feature short, to the point clips from our full-length interviews. We talk to the men and women behind the trades, crypto exchanges, and regulations with the goal of helping you become a better, more informed investor.
Michael: Hi. I’m Michael Kaplan, editor of the Flippening Podcast. Today’s episode is taken from a 2018 conversation with Stephen McKeon, economist and professor of finance at the University of Oregon’s Lundquist School of Business. We discuss use cases for stablecoins and Stephen’s view that they represent the clearest path to mass [00:00:30] cryptocurrency adoption. For the full conversation, check out Flippening Episode 19.
This episode has two sponsors:
The first sponsor is Nexo, which offers INSTANT crypto credit lines. Check them out at Nexo.io. Our second sponsor is the Nomics Cryptocurrency Market Cap & Data API for institutions, fintech apps, and funds.
Without further ado, here’s our conversation with Stephen McKeon from the Lundquist School of Business. Enjoy.
Clay: Having spoken with you a bit, I think the best entry point into this discussion is an overview of your thoughts [00:01:00] on stablecoins. I’ve had lots of guests on this show and opinions are really varied on this topic, to say the least, but to be fair, most of the people I’ve had on the show are viewing stablecoins through the lens of an investment opportunity rather than a lever for economic change. As an economist, Stephen, what are your thoughts on stablecoins?
Stephen: I’m so glad you asked me this because stablecoins are probably the one thing I talk about almost as much as security tokens and traditional asset tokens. I guess the TL;DR version [00:01:30] is that we need one. Stablecoins solicit strong opinions from both proponents and skeptics. A lot of that debate centers around feasibility, particularly with the algorithmic versions. But I’ve also seen people ask why we need a stablecoin? Let me address that.
Just to be clear, my definition of a stablecoin would be a class of cryptocurrencies that exhibits low price volatility relative to a benchmark. That benchmark might be US dollars, Euros, [00:02:00] or any other unit account. If the desire is stability against the price of goods and services, then there must be an index that stands proxy as the unit of account. But if you think about the problem we’re trying to solve, there are at least two economic concepts behind the demand for stablecoins, it would be currency mismatches and price stability.
If you step back from crypto for just a minute to convey the concept of currency mismatches, these are things that induce currency risks. Think about [00:02:30] taking out a fixed-rate mortgage loan to purchase a home but instead of taking out the loan in your native currency, you borrow in a different currency, perhaps because the interest rate is lower. Now in exchange for the lower interest rate, you’ve given up certainty about the cost of your mortgage each month in terms of your native currency where you generate your income.
Fast-forward a little bit, and assume the interest rate moves against you, then nothing else has changed, you are in the same income, you live in the same house, same mortgage same interest rate. But now the payment [00:03:00] in terms of your native currency has increased substantially. Depending on the rest of your budget, that difference might constitute the entirety of your disposable income. It actually turns out that more than a million households suffered this exact fate in 2015 when the Swiss franc was unpegged from the Euro and moved 16% in a month because borrowers from all over Europe had mortgages [00:03:30] denominated in Swiss francs because they could get a lower interest rate.
This currency mismatch exposes the transaction participants to currency risk. In this example, it combined a speculative investment on currency with a mortgage. There was a coupling of these two things. Now in many transactions, people don’t want to bear the additional currency risk through speculation, particularly if they can establish that speculative position independently. [00:04:00] I want to be clear that saying we need a stablecoin is not taking anything away from Bitcoin, it’s just a different use case.
As you mentioned at the beginning, some people will point to hyper-Bitcoinization where Bitcoin is the global reserve and at that point, Bitcoin is the stablecoin because everything is priced in Bitcoin. But even if that’s your position, you have to acknowledge that we’re a ways away from that, and perhaps, there’s a transitional role for a stablecoin today. You can hedge out [00:04:30] this currency risk using Bitcoin futures but it doesn’t solve the problem entirely because futures might work for some transactions but not others.
Take up sale of a home, anytime there’s any contingency, you’ve got an issue because what if I enter a futures contract but the house fails an inspection midway through the escrow period, meanwhile, the price of Bitcoin has mooned so I’m left with this loss on the futures but no offsetting gain [00:05:00] from the house sale? Contingent transactions are not good candidates for hedging with futures. Plus most people just don’t want to have to manage a futures position just to use smart contracts and transact in cryptocurrencies.
This overarching issue is that we live in a world priced in fiat which is colliding with smart contracts that require a crypto unit of account. This mismatch creates friction which slows the adoption of tokens as a [00:05:30] means of exchange. Prices in all currencies adjust over time. The issue is that they’re not adjusting in lockstep. It’s important to understand that this stability problem is temporal in nature. It’s not a function of one currency being inflationary and another deflationary, it’s that the rates of inflation and deflation are time-varying. They don’t move in the same amount at the same rate. If they did, it would be easier to solve.
This mismatching [00:06:00], it adds uncertainty to decisions made today about prices and transactions in the future. By adding this currency risk, it acts as a friction to trade because what economists call the certainty equivalent is reduced. This idea with stablecoins is to disentangle the ability to store and exchange value in the form of a token from the concomitant speculation on exchange rates to try and decouple [00:06:30] those two things. There are all kinds of scenarios where the separation in time between the moment of contracting, the moment of value transfer occurs.
Stablecoins are a more natural fit for credit products, for prediction markets, for transactions for goods that are priced in fiat and involve a time delay in delivery. Something as simple as buying a phone, Vitalik actually tweeted about this in December, what happens if you spend ETH, you purchase a phone but then the price of ETH [00:07:00] moves, and the seller decides not to ship it? I became interested in stablecoins, at the same time, he became interested in traditional asset tokens because these assets generate recurring distributions like lease payments.
But an even larger category of recurring payments is payroll. What happens if payroll services want to utilize smart contracts? I think the volume of value transfer via payroll is underappreciated in this space. [00:07:30] Consider this, Amazon, a very large retailer, they received $136 billion in payments last year. That sounds like a lot but it’s actually not a lot compared to the amount of value transferred through payroll systems.
ADP, one payroll processor processed $1.35 trillion in payments last year. Payments, in exchange for labor, are one of the largest value transfers on earth [00:08:00] and recurring payments like salaries are much more likely to switch to a token-based system using stablecoins versus one where you’ve got currency mismatching. Those are the alternatives right now.
Stablecoins allow people to store value in tokens without bearing currency risk, and regardless of how you want to construct your investment portfolio even if you still want to hold Bitcoin, stablecoins are a more natural fit for storing value that’s expected to be spent in the near term like the amount you might keep [00:08:30] in your checking account. They’re a unit of account with which people are already familiar.
To me, they are really the gateway in the transition from fiat to a token-based means of exchange for the broad economy. I think they represent one of the clearest paths to adoption in my view. Let’s acknowledge that a universally accepted stablecoin is not here yet, there are lots of challenges. I’m not stating an opinion on whether the winner will look like a fiat-backed reserve like TrueUSD [00:09:00] or ARC Reserve Currency or a crypto-backed version like Maker or an algorithmic version like Basis.
There are going to be lots of speculation and probably, some of these will blow up spectacularly. But I think my bigger point is that the effort is worthwhile because if we can find a structure that works, it will facilitate a migration to payments on crypto rails for a wide variety of financing activity that’s still on the sidelines.
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