1. Campbell R. Harvey Duke University and NBER
Innovation and Cryptoventures
Stablecoins
Campbell R. Harvey
Duke University and NBER

2. Cryptocurrencies are too volatile
Bitcoin as a transaction method will not be viable until the volatility is decreased. Currently, it fails as a store of value.
Campbell R. Harvey 2019

3. Cryptocurrencies are too volatile
Holding for one week: 95% confidence interval is
Bitcoin: +/- 25%[from 2011]; S&P500 is -4.3% to +4.3%
Worst S&P daily return since 1957 is Oct. 19, 1987 at %
Over last 6 years, bitcoin has had 8 days with less than % return
Second worst daily return since 1957 is Oct 15, 2008 at -9.03%
In 2018 alone, more than 8 days with <-10% return
Campbell R. Harvey 2019

4. Stablecoin basics Four different types Fiat collateralized
Real asset collateralized
Crypto collateralized
Non-collateralized
Campbell R. Harvey 2019

5. Stablecoin basics Fiat-collateralized coins
Tether is the largest (USDT) also very controversial
TrueUSD (TUSD) exchange directly into escrow so TUSD never touches your USD
LBXPeg tied to sterling;
BitCNY
Candy backed by Mongolian tugrik
Sometimes called IOU coins – if there was ever a problem with the collateral, the token holders are owed the fiat.
Campbell R. Harvey 2019

6. Stablecoin basics Fiat-collateralized coins
USDC (Circle) accepted on many exchanges like Poloniex (which Circle owns)
Paxos Standard (PAX) and Gemini Dollar (GUSD) approved by New York State Department of Financial Services
Campbell R. Harvey 2019

7. Stablecoin basics
Campbell R. Harvey 2019

8. Stablecoin basics Real asset-collateralized coins
Digix Gold (DGX) ERC-20 and 1 DGX=1 gram of gold. Gold in vault in Singapore and audited every three months.
Can redeem (recast) in physical gold in 100g or 1000g lots. Need to be physically present
Proceedures fully compliant with AML/CFT regulations set out by the monetary authority of Singapore.
Transaction fee of 0.13%
Daily Demurrage Fee covers the cost of vault and audit is 0.60% (annualized)

9. Stablecoin basics Real asset-collateralized coins
Tiberius Coin (TCX) combo of 7 precious metals used in tech hardware
Technology Metals: Tin (14%) and copper (23%)
Electric Vehicle / EV Metals: Cobalt (10%), nickel (11%), and aluminum (7%).
Stability Metals: Gold (17%), palladium (13%), and platinum (6%).
Fees claimed less than 2% p.a.
Sale delayed due to credit card companies asking for high fees

10. Stablecoin basics Real asset-collateralized coins
Swiss Real Coin (SRC) backed by portfolio of Swiss real estate. Interesting, the holders vote on the investment choices!
This is an Security Token Offering (STO) that will take place in Reservations live.

11. Stablecoin basics Real asset-collateralized coins
Swiss Real Coin (SRC) backed by portfolio of Swiss real estate. Interesting, the holders vote on the investment choices!
This is an Security Token Offering (STO) that will take place in Reservations live.

12. Stablecoin basics Real asset-collateralized coins
D1 Coin. Collateralized with diamonds. Each D1 coin is pegged to 1/1000th of the value of D1 standard grade diamond
Ethereum ERC-20
5% fee for receipt of diamonds
2.5% for issuance and redemption of D1 coins
White paper

13. Stablecoin basics Real asset-collateralized coins
D1 Coin. Collateralized with diamonds.

14. Stablecoin basics Real asset-collateralized coins
D1 Coin. Collateralized with diamonds.

15. Stablecoin basics
Real asset-collateralized coins
D1 Coin.

16. Stablecoin basics Crypto-collateralized coins:
Suppose you own a house and want a home equity loan. The bank gives the loan but you pledge your house as collateral. The collateral is worth more than the loan (over-collateralized).
If the house drops in value, the loan may be called. If you can’t payback, the house is auctioned off.
This is an example of a Collateralized Debt Position or CDP
Campbell R. Harvey 2019

17. Stablecoin basics Crypto-collateralized coins:
Let’s do a deeper dive on MakerDAO’s DAI
It is an ERC-20 token which means it is native to the Ethereum blockchain. The token represents a small amount of ETH but also represents DAI (which has a much higher value)
Campbell R. Harvey 2019

18. Stablecoin basics
Campbell R. Harvey 2019

19. Stablecoin basics Crypto-collateralized coins: MakerDAO
DAI is a cryptocurrency that is has a mechanism that allows it to be pegged to the USD. So $1=1 DAI (approximately).
In existence for about one year.
Campbell R. Harvey 2019

20. Stablecoin basics Crypto-collateralized coins: MakerDAO
Suppose 1 ETH= $100. In addition, suppose the initial collateral ratio is 1.5 (you must post $1.50 in collateral for every DAI borrowed)
You send 1 ETH to a smart contract which allows you to borrow 66 DAI (some rounding). There is also a “stability fee” which is similar to interest.
As long as ETH>$100, then the system is secure. However, what happens if ETH drops in value?
Campbell R. Harvey 2019

21. Stablecoin basics Crypto-collateralized coins: MakerDAO
Suppose ETH drops to $75. In addition, the “maintenance” margin collateralization ratio is The drop in ETH triggers the equivalent of a margin call.
If you are close to the maintenance margin, you need to repay by sending 66 DAI to the contract. After doing that, you would be refunded the ETH (about 1 ETH, there is a stability fee)
If you do not repay and you go below the collateralization ratio, you will be liquidated.
Campbell R. Harvey 2019

22. Stablecoin basics Crypto-collateralized coins: MakerDAO
There is a group called “keepers” that are constantly checking the blockchain for contracts that have fallen below the maintenance margin. They can trigger a liquidation.
Keepers is a general term for those that maintain a blockchain – they are not specific to MakerDAO
Campbell R. Harvey 2019

23. Stablecoin basics Crypto-collateralized coins: MakerDAO
There is much more to the system than my explanation
The maker token (MKR) holders determine the collateralization rates and they regulate the system (and get paid for it)
However, MKR are the buyers of last resort – if there was ever a situation where there was not enough collateral to cover the DAI, MKR is created and sold to cover the residual
MKR holders are, hence, strongly incented to responsibly regulate.
Campbell R. Harvey 2019

24. Stablecoin basics Crypto-collateralized coins: MakerDAO
There is also a fail safe called Global Settlement
If the system under attack, a Global Settlement is triggered where you can exchange the DAI directly for ETH through a smart contract and collateral will be released to the owners
Campbell R. Harvey 2019

25. Stablecoin basics Crypto-collateralized coins: MakerDAO
DAI also allows for leveraged ETH positions
Suppose you have 1 ETH = $100 and you enter into a CDP and get 66 DAI.
You use DAI to buy more ETH (0.66 ETH). [Assume do this only once.]
Now you profit (or lose) with leverage.
Suppose price rises, e.g., ETH=$200
You would usually have profited by $100 or 100% return
You have 1.66 ETH which is worth $332. You buy 66 DAI for $66 and repay the CDP leaving you with $266 (a profit of 166%)
Campbell R. Harvey 2019

26. Stablecoin basics Crypto-collateralized coins: MakerDAO
Finally, currently the system allows for only one type of collateral: ETH
In the future, they will generalize this to any ERC-20 or ERC-721 token
This opens a range of interesting ideas. For example, you might have an ERC-20 that represents an investment in a diversified portfolio of stocks and bonds. Essentially, almost any collateral (as long as it is tokenized) can be pledged.
Campbell R. Harvey 2019

27. Stablecoin basics Crypto-collateralized coins: MakerDAO
Other information
Andy Milenius at Devcon4, December 10,
Campbell R. Harvey 2019

28. Stablecoin basics
Non-collateralized coins: Basis, Kowala, Fragment/Ampleforth
Common feature: a dynamic monetary policy to target a particular exchange rate (much like Central Banks attempt)
For example, the Swiss National Bank was worried about CHF appreciating. They tried to peg to Euro.
Wednesday January 14, 1.2 CHF= 1 Euro
Thursday January 15, 0.85 CHF = 1 Euro
Campbell R. Harvey 2019

29. Stablecoin basics
Basecoin – Basis protocol. Dynamic monetary policy that uses a three token system (coin, bonds and shares). They had to shut down December 18, 2018 because regulatory issues (bond and stocks were securities). Nevertheless, let’s explore their idea.
1. Coin (Basis):
Supply shifts to keep demand at, e.g., $1 to maintain peg
If price increases, more coin is created; if price decreases, coin is purchased to decrease supply
“A stable cryptocurrency with an algorithmic central bank”
Campbell R. Harvey 2019

30. Stablecoin basics Non-collateralized coins 2. Bonds: (Bond token)
Generated whenever supply needs to contract
Bonds are redeemable for 1 coin in future if:
Supply is expanding
Bond hasn’t expired (5-year window)
Your bond is next in line (oldest redeemed first, FIFO)
Sold for less than $1 to achieve yield (here is where the regulatory issue kicks in because qualifies as a security)
Campbell R. Harvey 2019

31. Stablecoin basics Non-collateralized coins 3. Shares: (Share token)
Supply is fixed
Not pegged to anything. Value determined by dividend policy. When demand for basis goes up and blockchain creates new basis, new basis paid to shareholders (after outstanding bonds)
Payments are proportional to ownership (again seems like a security)
Thus bonds incentivize contraction of supply and bond and shareholders are recipients of expanding supply and the peg can be maintained “via game-theory and economics”
Campbell R. Harvey 2019

32. Stablecoin basics Kowala protocol
Vision is a series of k-coins, kUSD, kEUR, … (each coin has its own blockchain)
White paper
Three stability mechanisms
1 second confirmations in Go Ethereum (Using Ethereum code but important change to consensus mechanism for their own blockchain)
There are three popular clients, eth –client written in C++; geth –client written in Go (language designed at Google and similar to C), pyethapp –client written in python. All of these interact with Ethereum (and testnet) blockchain. Think of you being able to send an using Outlook to someone else who uses Gmail.
Campbell R. Harvey 2019

33. Stablecoin basics Kowala protocol
Stability mechanism #1: Minting algorithm
If kUSD rises above $1, then more supply is added (so the block reward is variable)
If kUSD falls below $1, mining reward goes to zero – however, that might not be sufficient to drive the price back
Campbell R. Harvey 2019

34. Stablecoin basics Kowala protocol
Stability mechanism #2: Stability fee
Like Ethereum, every transaction sender is charged a fee (in part to compensate miners for maintaining the network). This fee also includes a “stability fee” which is 0-2% of the transaction amount. The fee serves to reduce coin supply when price is below $1. Note the max is 2% and usually the stability fee would be zero (in normal conditions). Also, no one pockets the fee. The coin is destroyed.
Campbell R. Harvey 2019

35. Stablecoin basics Kowala protocol
Stability mechanism #3: Trading activity
First two mechanisms are first order effects and are designed to keep kUSD close to $1. There is a second order effect. Given that market participants understand the peg, there exists a natural Schelling* (focal) point ($1=1 kUSD). That is, arbitrageurs will enter the market if the price falls below $1 and start to buy.
*In Game Theory, a solution that people will use in the absence of communication. Named after Thomas Schelling (Nobel 2005).
Campbell R. Harvey 2019

36. Stablecoin basics Kowala protocol Other
Two token system: kUSD and mUSD, where mUSD is a mining token. There is a fixed number of mUSD for every kUSD.
Consensus mechanism (Konsensus) derived from Tendermint and uses Practical Byzantine Fault Tolerance* (pBFT). They believe superior to Proof of Work.
There are miners. For every block, a leader (called proposer) is deterministically elected from miners. All other miners are validators. Proposer assembles the next block and the validators decide whether to accept or reject. Proposer gathers pending transactions of offers to the validators for formal verification. If two thirds or more vote to accept the block, proposer commits it to the blockchain. If block is rejected, a new proposer is elected.
The likelihood of being elected as a proposer depends on the number of mUSD you have. *

37. Stablecoin basics Kowala protocol Other
Dishonest or free-loading miners punished by becoming ineligible to propose blocks (need to be active to participate); Also, in order to be eligible, miner needs to stake mUSD tokens (currently 30,000); Maximum number of miners;
Based on Ethereum for smart contract purposes
Energy efficient
7,000+ tps with processing time of 1 second
Campbell R. Harvey 2019

38. Stablecoin basics NuBits
If demand exceeds supply (usually price would go up), NuBits introduces additional circulation into supply. The new supply is authorized by NuShareholders
If supply is greater than demand (usually price falls), excess digital taken out of circulation. NuShareholders buy the excess supply.
Depending on performance of NuBits, NuShareholders are issued dividends by platform.
If demand low for prolonged period of time, NuShareholders can authorize creation of more NuShares.
Example of Seigniorage shares category of stablecoins
Campbell R. Harvey 2019

39. Stablecoin basics NuBits 2016 saw large deviation from peg
At this time, bitcoin and other cryptos were sharply appreciating
Large selling of Nubits by those wanting to buy non-stable cryptos
Campbell R. Harvey 2019

40. Stablecoin basics NuBits
However, notice that it returned to parity. Perhaps arbitrage traders? But oddly, at a number of points it goes to more than $1.25 at the end of –around the same time bitcoin is crashing. Uncertainty about bitcoin caused demand for NuBits, driving the price beyond parity.
Campbell R. Harvey 2019

41. Stablecoin basics NuBits
Converting bitcoin to USD is slow (and in a crash situation, you need to be fast). Also, there are tax consequences. Converting to NuBits was quick.
NuBits printing money and selling it to bitcoin holders. As cryptomarket crashes, demand for stablecoins increases (less so with collateralized)
Tether
Campbell R. Harvey 2019

42. Stablecoin basics NuBits NuBits crashes again March 21, 2018.
Lack of reserves. As price starts to fall there is a “bank run”, and people try to sell the NuBits
One factor was that NuBit reserves were stored in bitcoin! Essentially, the collateral was not diversified.
Campbell R. Harvey 2019

43. Stablecoin basics
NuBits
Campbell R. Harvey 2019

44. Stablecoin basics
NuBits
Other
Campbell R. Harvey 2019