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Is it counterintuitive to peg a cryptocurrency to the value of the dollar and simply use it as a means to efficiently send money?
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11 Answers
Certainly a cryptocurrency pegged to the dollar would be valuable for many use cases.
However, there are two ways to accomplish that; and they both have problems:
1. Central Backing
That is, there is a central issuer of the currency, that buys the currency at $0.99 and sells the currency at $1.01 (for example).
The problem here is this central authority becomes the regulatory target. It is responsible for acquiring the monetary licenses in every jurisdiction in which customers are accepted; it is responsible for complying with KYC and AML regulations, and it is responsible for policing usage of the currency.
That of course seems quite unfair, as the United States Mint and Federal Reserve Banks bear no such burdens for creating and circulating USD; but life simply isn't fair.
The second problem -- why the first problem is inescapable -- is that the dollar reserve of the central authority becomes a target.
Say, for example, the DOJ traced the proceeds of a crime, $200,000 USD, into the cryptocurrency. The DOJ can simply seize $200,000 from the issuer and say, this currency represents that which was illegitimate, you figure how to settle your books. And they need not take it directly form the issuer, just from any correspondent USD bank account of any bank that supplies banking services to the issuer; or if that fails, via bilateral treaty and extortion.
2. No backing, defended peg
The other option is to have no central backing of the currency, but have many (distributed) organizations willing to attempt to defend the currency peg. That is, they also buy at $0.99 and sell at $1.01 (for example).
The problem here is that if there is more demand than supply of the cryptocurrency, how do you inflate the supply such that there are units to sell to keep the peg? Any organization able to get the units via inflation is going to accumulate fiat currency, and run into all the problems specified above.
If supply overhangs demand, then these organizations buying need deep pockets; and ultimately are going to suffer from not trusting each other.
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So ultimately a currency peg cannot be defended unless the backing problem is solved via regulatory changes or regulatory engineering.
However, there are two ways to accomplish that; and they both have problems:
1. Central Backing
That is, there is a central issuer of the currency, that buys the currency at $0.99 and sells the currency at $1.01 (for example).
The problem here is this central authority becomes the regulatory target. It is responsible for acquiring the monetary licenses in every jurisdiction in which customers are accepted; it is responsible for complying with KYC and AML regulations, and it is responsible for policing usage of the currency.
That of course seems quite unfair, as the United States Mint and Federal Reserve Banks bear no such burdens for creating and circulating USD; but life simply isn't fair.
The second problem -- why the first problem is inescapable -- is that the dollar reserve of the central authority becomes a target.
Say, for example, the DOJ traced the proceeds of a crime, $200,000 USD, into the cryptocurrency. The DOJ can simply seize $200,000 from the issuer and say, this currency represents that which was illegitimate, you figure how to settle your books. And they need not take it directly form the issuer, just from any correspondent USD bank account of any bank that supplies banking services to the issuer; or if that fails, via bilateral treaty and extortion.
2. No backing, defended peg
The other option is to have no central backing of the currency, but have many (distributed) organizations willing to attempt to defend the currency peg. That is, they also buy at $0.99 and sell at $1.01 (for example).
The problem here is that if there is more demand than supply of the cryptocurrency, how do you inflate the supply such that there are units to sell to keep the peg? Any organization able to get the units via inflation is going to accumulate fiat currency, and run into all the problems specified above.
If supply overhangs demand, then these organizations buying need deep pockets; and ultimately are going to suffer from not trusting each other.
---------------
So ultimately a currency peg cannot be defended unless the backing problem is solved via regulatory changes or regulatory engineering.
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It is a nice idea, but you will run into problems if you try. Countries have tried doing this and you end up with some standard problems. If you have all your cash in reserve, this will work (i.e. Hong Kong or casino chips) but you then run into regulatory hell, and one problem is that even if you are keeping a 100% reserve, people might not believe you.
Now if you don't keep a 100% reserve, then you are just painting a target on you and daring traders to break the bank. What people will do is if you guarantee 1:1 exchange, but you don't have reserves, is that they will borrow peg-coin, sell it to you, get the dollars, and try to force you to run out of money. Once you run out of money, at that point the trader will buy peg-coin very cheap and pay off the loan.
Now remember that people have successfully preformed the strategy against entire *countries* including the United States in 1971 and the United Kingdom in the early-1990's. If you try this, it will be amusing to watch the outcome (google for Bambi meets Godzilla).
Now if you don't keep a 100% reserve, then you are just painting a target on you and daring traders to break the bank. What people will do is if you guarantee 1:1 exchange, but you don't have reserves, is that they will borrow peg-coin, sell it to you, get the dollars, and try to force you to run out of money. Once you run out of money, at that point the trader will buy peg-coin very cheap and pay off the loan.
Now remember that people have successfully preformed the strategy against entire *countries* including the United States in 1971 and the United Kingdom in the early-1990's. If you try this, it will be amusing to watch the outcome (google for Bambi meets Godzilla).
Even if you leave the technical issues (e.g., missing mining incentives) behind, you still face economic/business issues:
Successful pegging requires trust of all parties in the peg. That means, if anyone (let's call the entity "BitCo" for the sake of the argument, which could be a company or any type of organization) creates the new currency (let's call it "BitDollar"), there are two options:
In the letter case, pegging would work, but it is an inherently unstable system:
In fact, what you would have created sounds a lot like Liberty Reserve.
Compare to this to the beauty of Bitcoin:
So to answer your question, it's not counter-intuitive, but it's hard to put into practice. And the question is, whether it's desirable given the obvious drawbacks.
Successful pegging requires trust of all parties in the peg. That means, if anyone (let's call the entity "BitCo" for the sake of the argument, which could be a company or any type of organization) creates the new currency (let's call it "BitDollar"), there are two options:
- BitCo distributes the new BitDollars in some way and tells everyone they are worth exactly $1 each. BitCo just created a bunch of money out of thin air, and I doubt anybody would assume 1 BitDollar to be worth $1.
- BitCo sells BitDollars for $1 each, and offers to buy and sell BitDollars at any given time for $1 (not assuming fees). In order to keep the system in balance, BitCo now must hold real US-$ for each BitDollar it has minted.
In the letter case, pegging would work, but it is an inherently unstable system:
- Everybody has to trust BitCo to guarantee the value in the future, and keep the real Dollars available, while on the other hand there is a great economic incentive for BitCo to devalue the BitDollars, invalidate them altogether, or simply shut the system down and run away with the real cash
- BitCo is a single source of failure to any form of attacks (including technical failures, hacks, internal fraud, theft of real cash, ...)
- It's a regulatory nightmare for BitCo
In fact, what you would have created sounds a lot like Liberty Reserve.
Compare to this to the beauty of Bitcoin:
- You neither have to trust nor depend on any single entity - even if there is only a small number of computers left which run the Bitcoin software, the system continues to work
- Prices settle purely based on supply and demand (which effectively serves as proxy for trust and extent of participation in the overall Bitcoin network) - with no single entity being accountable for ensuring a certain value
So to answer your question, it's not counter-intuitive, but it's hard to put into practice. And the question is, whether it's desirable given the obvious drawbacks.
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I used to want to find a way to do this, but in studying economics I realized that pegging a cryptocurrency to an asset would make it worth LESS than that asset, not more.
Cryptocurrencies ARE assets. Their Utility is extremely valuable. How much would you pay to quietly move a billion dollars of fiat or gold from london to singapore? It almost can't be done... But that wealth can move for FREE with a cryptocurrency, assuming the market cap is large enough to fit it in.
One day soon bitcoin, having the highest liquidity of all cryptos, will be the most valuable unit of any asset class... How could that need to be tied to some inferior yellow rock to make it more valuable??
Cryptocurrencies ARE assets. Their Utility is extremely valuable. How much would you pay to quietly move a billion dollars of fiat or gold from london to singapore? It almost can't be done... But that wealth can move for FREE with a cryptocurrency, assuming the market cap is large enough to fit it in.
One day soon bitcoin, having the highest liquidity of all cryptos, will be the most valuable unit of any asset class... How could that need to be tied to some inferior yellow rock to make it more valuable??
This now exists in a couple of forms, BitUSD and Nubits (this being the latest one, and it is Peershares based) being 2. Aside from BitUSD I think there are a couple more Bitshares based ones.
Some rambling about Nubits if you care to read:
Nubits has an interesting system to keep it pegged to the dollar, but we'll have to see how resilient it is against the kind of attack Joseph Wang described in his answer. The developer Jordan Lee says the peg should be stronger than BitUSD.
What their white paper says:
If someone consumes a huge amount of the buy side liquidity, the idea is that if you increase interest rates then you'll restore demand. Additionally it's likely that they'll keep a significant portion of the USD generated from Nubits sales in reserve.
Between these 2 it might be possible to maintain buy side liquidity, but I don't know for sure. There is also discussion about using a small spread to pay for exchange fees and such, and that would help too.
Some rambling about Nubits if you care to read:
Nubits has an interesting system to keep it pegged to the dollar, but we'll have to see how resilient it is against the kind of attack Joseph Wang described in his answer. The developer Jordan Lee says the peg should be stronger than BitUSD.
What their white paper says:
It is important that deep NuBit liquidity exist at one USD, on both the sell side and buy side. Custodians provide the sell side liquidity as they place NuBits granted to them for sale. This leaves the buy side, the side where liquidity supports the price at one USD. While the market will naturally have a buy side, it may be thin, particularly when demand for NuBits is in decline. A pool of liquidity is needed to stabilize the price, to assure holders of NuBits that they can exit a large position at will and it is also needed to provide the signal to raise interest rates before the price has a chance to drop below one USD. For instance, if there is total pool of buy side liquidity of 100 million dollars, and demand for NuBits declines, the buy side liquidity will begin to be consumed as holders of NuBits sell. Shareholders need to gain awareness of this pool decreasing, as it will be their signal to raise interest rates to increase NuBit demand and replenish the buy side liquidity pool. It is important that shareholders increase interest rates enough before this buy side liquidity is consumed, because if that occurred, the price could drop below one USD briefly.
If someone consumes a huge amount of the buy side liquidity, the idea is that if you increase interest rates then you'll restore demand. Additionally it's likely that they'll keep a significant portion of the USD generated from Nubits sales in reserve.
Between these 2 it might be possible to maintain buy side liquidity, but I don't know for sure. There is also discussion about using a small spread to pay for exchange fees and such, and that would help too.
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It's very intuitive from the user's perspective, it's difficult but not impossible to achieve from the technical implementation.
This is one of the major features that Mastercoin will include.
This is one of the major features that Mastercoin will include.
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