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The bearish crypto market conditions this year have shown there is a definite need for a stablecoin. Lack of such a token has caused selling pressure from risk aversion perspective which in turn generates volatility as everything had to be rotated back to BTC or ETH before entering fiat. This limits risk reduction through diversification.
In finance, we refer to this as the beta coefficient from the Capital Asset Pricing Model (CAPM). A beta coefficient is a measure of asset volatility that can’t be reduced with diversification. Fund managers can use stablecoins to provide investors with a means to diversify out of the crypto market without causing a selling ripple effect in the market. This translates to lower transactions cost and greater nimbleness in asset allocation.
Recently, we’ve seen the NYDFS release a statement regarding its regulation of two trust companies, Gemini Trust Company, LLC (Gemini stablecoin GUSD) and Paxos Trust Company, LLC (Paxos stablecoin PAX). It’s great to see regulators move forward with creating a structure for USD tokenized assets.
For a while, Tether Limited pioneered the stablecoin scene with USDT and no one asked too many questions about it because it served such a crucial need. Tether’s term of service has changed multiple times, and its redemption process is not easily accessible to retail traders. It’s also important to note that retail traders make up a large portion of Tether holders. Regardless of what the market’s opinion is of Tether, it has served its purpose as the proof of concept for an electronic dollar, and that was the main focus for the large financial institutions.
At the time of writing this article, here are the biggest holders of Tether:
With that being said, let’s look at some of the major players entering the realm of stablecoins:
Circle Internet Financial Limited is the company behind USDC. Circle as a company is one of the most the reputable firms in the crypto space. Circle has been around for some time now, and one of its most notable backers is Goldman Sachs. The firm’s decision to participate in Circle happened during Lloyd Blankfein’s tenure as CEO, and the firm’s current CEO, David Solomon, is also keen on blockchain technology. This can be seen both in the firm’s positioning in the market as well as their PR.
Circle undoubtedly has a very diversified holding within the crypto market. The company acquired Poloneix earlier in 2018, and now has its USD stablecoin listed on Coinbase. If it goes through, Circle’s acquisition of Seedinvest will enable the firm to expand its offerings to support issuing and offering tokenized securities. These pieces will provide Circle the opportunity to control the exchange, the future tokens, and the electronic cash – effectively a large portion of the digital money supply.
TrueCoin, LLC in association with trust companies based in Nevada, Prime Trust LLC and Alliance Trust Company LLC. Prime Trust LLC is a reputable company that was established in 2016 and is led by Scott Purcell. Scott founded Newport West Custodial Services, which he built to $1 billion AUM and sold to Commerce Bank of Newport Beach.
Due to TrueUSD’s operational structure, as explained in more detail on their website, TrueUSD’s issuer is regulated at the federal level as a money services business (MSB) by the Financial Crimes Enforcement Network (FinCEN). Their legal framework enables users to exchange USD directly with an escrow account. With this structure, TrueUSD never touches any money and the funds are insured by a Financial Institution Bond up to $5,000,000.
Their open source smart contracts ensure a 1:1 parity between TrueUSD and USD in the accounts. After completing their KYC/AML process and wire funds to the third-party escrow accounts, an equivalent amount of TUSD is freshly minted to your ethereum address. Each TUSD represents a redeemable certificate for one US Dollar held in escrow for the benefit of the TUSD holder.
The Gemini dollar is issued by Gemini Trust Company, LLC, a New York trust company. The Gemini dollar is a token built on the Ethereum network according to the ERC20 standard for tokens. Their smart contracts has been audited by Trail of Bits, Inc., an information security research and development firm, whose report is publicly available here. The fact that their smart contract was audited provides an additional security level to prevent critical penetration attacks.
Issued funds are held in state Street Bank and Trust Company. Unlike other stablecoins, the U.S. dollar deposit balance is examined monthly by BPM, LLP, a registered public accounting firm, in order to verify the 1:1 peg. To further provide transparency, all Independent accountants’ reports are published and available here. It is currently listed on more than 30 exchanges that include big names like OKex, Huobi Global, HitBTC etc. Since Gemini is U.S. regulated, they enforce KYC/AML as part of their compliance. It seems like Gemini has taken all the necessary steps to cultivate a transparent, secure and U.S. compliant stablecoin.
Paxos Standard is issued by Paxos Trust Company, a financial institution that is overseen by its regulator, the New York State Department of Financial Services. It is also hosted on the Ethereum blockchain, which follows the ERC20 protocol. Their smart contract has been audited by Nomic Labs, an independent third-party smart contract security auditor.
Paxo clearly states that all cash deposits that collateralize Paxos Standard are held at U.S.-domiciled, FDIC-insured banks. Similar to previous stablecoins described in this post, if the company suffers a loss of funds that falls under FDIC insured policies, token holders are protected. They are also audited by a top-ranking auditing firm, Withum, that performs month-end attestations on Paxos Standard bank accounts to ensure 1:1 holdings. Customer funds are held in segregated accounts at FDIC-insured US banks. There are no fees that Paxos charges because they are the issuer. Once again, we see another stablecoin issuer that took extra steps to provide transparency and security within U.S. regulatory framework.
It’s important to point out that stablecoin companies are gaining access to controlling the money supply in a tokenized way. Similar to how the Federal Reserve is able to print money to control the money supply, stablecoins are able to issue or burn the supply of tokens.
In early days of Tether, there was a lot of speculation about it not being backed by actual holdings. Such speculation reinforced the argument of money being printed out of thin air. However, the purpose of this article is not to speculate on early Tether days, or if they in fact had the reserve at all times, but instead, the takeaway should be, how we’ve progressed in the stablecoin industry with major players like Goldman coming in.
Will accountability and ethics be properly enforced by regulators, auditors and well established institutions as these professional products are rolled out to the market for risk management? As we’ve seen in the past with mortgage crisis, some of these establishments have failed to do so in the past and a lot of regular people got hurt. However, on paper, all the necessary provisions are in place to further develop crypto markets through stablecoins. Only time will tell how it will unfold.