SLP236 Nic Carter Stablecoins: Bullish or Bearish For Bitcoin?

Nic Carter of Castle Island Ventures, author and podcaster in the space joins me to talk about stablecoins.

What are stablecoins?
Who uses them?
What kind of volumes are we talking about?
What kind of platform risks are involved?
Are they bullish or bearish for Bitcoin?
STABLE act
Outlook for stablecoins going forward

Nic Carter links:

Twitter: @nic__carter
Castle Island Ventures

Relevant episodes:

Sponsors:

Stephan Livera links:

Podcast Transcript:

Stephan Livera [02:50]: Nic, welcome back to the show!

Nic Carter: Thanks Stephan! Thanks for having me back. This is either my second or third appearance, I can’t remember exactly.

Stephan Livera: I think it’s the second one, but yeah, certainly there’s a lot of interesting stuff going on, and I know you have been chatting about this whole topic as well, of stablecoins. So I thought it would be good to explore this topic together on: Is it bullish or bearish for Bitcoin? What are some of the things that we need to think about with stablecoins? So perhaps, to start off, just for listeners who might not be so familiar — what is a stablecoin and what are some of the main ones?

Nic Carter: Yeah, this is actually a topic of debate: What the definition of a stablecoin is. What should we even call them — it’s not even necessarily settled, that stablecoins is the thing to call them. But basically, the way I define them, is: a tokenized representation of a fiat currency that circulates on-chain. So that’s really the simplest definition. And then, there’s a number of different ways they try and target the return profile of that sovereign currency. The main way is just by being redeemable for units of that currency that are immobilized in a commercial bank. But there’s other ways. Some of them are, in my opinion, pretty crazy and not likely to work. The algorithmic uncollateralized model—I don’t think we’ve ever really seen that work. I think it’s unlikely to work. And then there’s the maybe more interesting approach, which is to take some crypto-collateral, which is volatile, and use that basket to create something which is more stable in terms of its risk profile with algorithmic risk management systems. And you could in theory do that against Bitcoin. And then there’s a final way to create stablecoins, which is to basically create a pair of Bitcoin derivative and a spot position, so you can have a short and a long position paired up together, and that’s one way to create a stable which we’re seeing out there. So there’s a bunch of different ways to do it, but the key idea is, Hey, public blockchains are great for moving value around—wouldn’t it be great if we could move stable value around? I know a lot of Bitcoiners don’t like this concept, but the truth is, it really is catching on, and it’s one of the early industry killer apps.

Stephan Livera [05:24]: I see. And it’s probably also good to contextualize here: what’s the kind of split in terms of the stablecoins? Are they, I presume, they are mostly — Tether is probably the elephant in the room here, right? Most of the stablecoin volume would be of that type, right? Like the type where it’s US dollars in a bank account somewhere, and these stablecoins represent some claim, or their value is meant to reflect those, right?

Nic Carter: Yeah that’s by far the most popular model, is the fiat collateralized or convertible model, whereby, in theory, by holding this token, you could again, in theory, redeem it for units of actual currency in a commercial bank somewhere. Now with Tether and actually other ones, there’s complications— not everyone can necessarily redeem it. You might have to be a special entity or you might have to have a certain threshhold in order to do that redemption. But it’s still the possibility of redemption which is the thing that keeps it trading around one dollar.

Stephan Livera [06:30]: Yeah. And so, who are the main users of these products?

Nic Carter: Well it’s hard to directly apprehend that, right? Because, if you’re using a stablecoin, you’re outside of the traditional financial system, and you might be outside of that system for good reason. You might be an import/export business operating on a cross-border between Russia and China, and you have very good reasons to not make your transactions known to the authorities. And so, you are strongly incentivized to not broadcast your usage of stablecoins. I think unambiguously the biggest consumers of stablecoins are just entities that are active in the cryptocurrency markets, so: traders, hedge funds, proprietary funds, arbitrage funds, market makers, these are the entities that need crypto-denominated liquidity, and they need an arbitrage or a market maker firm, you know, they’ll be active on dozens of exchanges at the same time. They need to manage their collateral. They might have a preference to hold it in fiat terms. They may not want to be directionally long Bitcoin at all times. So they might prefer dollar-based collateral. And so, stablecoins would be a good choice for them. They get the settlement assurances of using a public blockchain, but they also get to manage their risk in terms of volatility. So that’s a huge, huge consumer of stablecoins. Increasingly we just also have regular old businesses denominating their balance sheet in stablecoins, and more and more, the firms that we invest on, as a venture fund, will ask us for a stablecoin-denominated investment. They don’t want to get bank wires. They want USDC. And we’ve begun to do that as well. So what we’re seeing is the whole supply chain of some of these early stage businesses is flipping from commercial bank liquidity to on-chain liquidity, and it flips because they’ll receive investment in stablecoin terms, and then their expenditures will be denominated in stablecoin terms. This crypto industry is a globalized system where there’s less geographic hubs of consequence, and the talent is much more globally dispersed. For payroll for instance, for a global audience, it actually is generally more convenient to use something like USDT or USDC to pay people if you have employees in fifteen different countries. That’s probably cheaper and easier than the corresponding banking system. And so you see the whole supply chain of certain businesses flipping from being commercial bank based to being crypto-liquidity based. So that’s another really interesting new genre of stablecoin consumer that we’ve seen emerge this year. But yeah it was an easier question to answer two years ago when it really was just traders that was using stablecoins. Today it’s just all kinds of businesses, I mean we have FinTech providers, we’ve invested in some of these businesses that are giving stablecoin access—or intermediated access to stablecoins — in countries where there’s currency crises, as kind of a FinTech product. So yeah the phenomenon is really taking off and there’s a really heterogeneous set of entities that actually use these things.

Stephan Livera [10:16]: I think probably the obvious question that is going through many listeners’ minds—they might be thinking, Well hang on, why don’t they just pay directly in Bitcoin but denominate it in USD? And I can guess there’s probably some good answers for that. What would you speculate, or if you know? Why do you think that is?

Nic Carter: Yeah. I mean it’s a very fair question! I would say probably the main reason is the mental transaction cost of introducing a new numeraire. Now Bitcoin, probably about 50–100 million worldwide are familiar with Bitcoin, but probably half of the world’s population is familiar with the dollar. The dollar is the de facto global reserve currency. And then, even in countries where dollars aren’t the local currency, people still kind of know how to price things in dollars. They have an appreciation for the dollar. And this isn’t like my love-letter to the Federal Reserve or anything. It’s just a statement of reality. As a unit of account, the dollar is very popular. So I think people are just more comfortable in receiving payments in dollar terms, at this state of Bitcoin adoption. Of course, I expect that to change in the long term as Bitcoin becomes much more ubiquitous, but for now, stablecoins are kind of an intermediate or bridge asset where people are realizing, Hey, public blockchain infrastructure is actually a more convenient way to do business, especially on a cross-border basis. But they haven’t fully become used to Bitcoin as their unit of account, so for this transitional period, it’s a really suitable asset, basically.

Stephan Livera [12:05]: Right. And I presume it’s also a volatility aspect of it, that they would prefer to hold USD because maybe their expenses are in turn in USD in terms of their rent or their food and other living costs.

Nic Carter: Yeah, not everyone is like us and, you know, willing to tolerate the volatility of Bitcoin. And for payments while payments are in flight, you don’t necessarily want the exchange rate to be changing dramatically. So yeah, there’s good reasons to use the dollar. My view is that these things are strongly mutualistic, and so I don’t see cryptodollars as stablecoins as being a threat to Bitcoin in any way. I think they’re kind of supportive of each other.

Stephan Livera [12:51]: Yeah. And my understanding is also that there are traders who are using it to get around the exchanges quickly in terms of doing the fiat leg a bit faster for them to arbitrage and things like that. But there’s also this story of people in other countries around the world who want to get around capital or currency controls, in some cases, get their money out of the country. Have you seen that in your travels and your discussions in the industry?

Nic Carter: Yeah. I mean, this is an established concept today. So, Chainalysis, you know, a lot of people consider them to be villainous. They do put out some good research, so I would encourage your listeners to look at their report where they find — and I have no reason to doubt their methodology, I think it’s probably quite sound — they find about $50 billion worth of capital outflows from China taking place in Tether terms. So these are real numbers, and so that’s a story about evading capital controls. And now, the Chinese government may not like that, but we’re talking about a new epoch in payments technology. We’re talking about digital bearer assets. This is their manifestation. This is what people choose to use them for, and that’s just a reality. And if you look at Tether transactions, you can see they happen mostly during Asian trading hours. So they’re very, very popular as an alternative payment system, and a way to offshore wealth from countries that are engaging in monetary repression. A more direct answer, where I have firsthand experience, would be in places like Latin America, Argentina in particular, Venezuela and Colombia. In those three countries the currencies are very weak. There’s a big Venezuelan diaspora which is internally displaced within Latin America. There’s a number of startups that are using — there’s a lot of Bitcoin there — but there’s also a number of startups that are using stablecoins to give people a dollar savings device. Now there are dollars that are present in those countries, physical dollars. But they’re kind of hard to get your hands on, and they aren’t necessarily in the right denominations, there’s a lack of small denomination bills. And of course dollars are easy to seize. And there is Bitcoinization occuring, of course, but there’s also a movement where people are engaging in this cryptodollarization, where they are getting exposure to dollar-based products through public blockchains. Now, Bitcoin is critical in this whole process, but what people are really after, for the most part, is dollars. And they’re seeking dollars as a way to connect remittances, move money around, without asking for permission — but also as a wealth preservation device. We’ve invested in startups active down there doing exactly that. I think FinTech experiences that are built on top of cryptodollar rails are gonna be a much more pervasive concept in the next five years.

Stephan Livera: Yeah so it’s a range of different people who are using these stablecoins, whether it’s traders or companies who want to get funded in stablecoins, or people in the developing world who want to get around capital and currency controls. So my understanding as well is with some of the South American stories, is that there are all kinds of different ways that people are using different payments, whether that’s things like Zelle or some of these other normal fiat banking dollars, but this is just now presenting another option for people who want to try to — maybe they’re not necessarily looking for the maximum level of censorship-resistance, but they’re just using some of these different bank accounts and so on, and this is just another way of helping — maybe we can think of it like greasing the wheels, right?

Nic Carter [17:04]: Yeah. Zelle is very popular in Venezuela, you’re absolutely right. But Zelle is also created by a consortium of US banks, and those banks aren’t really too keen on having end-users in Venezuela, because there are no formal US sanctions on the country of Venezuela, but there are sanctions on members of the Maduro regime, and it’s kind of like taint, if you think about taint in the network graph. It’s basically the same concept. If you go to the coffee shop which is run by the nephew of the minister of transport, and he happens to be sanctioned, there’s a risk that you inherit that as well. So you become tainted by association, and then you get de-platformed from all of your Western FinTech and payment apps. And so that happens a lot. Wells Fargo has been on a real campaign to basically deplatform the Venezuelan users of Zelle. So Zelle is good UX and people really seem to like it, but it’s very much exposed to what the banks want to do. Now stablecoins have bank relationships, for most of them. The fiat-convertible ones, you know, those ultimately are claims on dollars in a bank. You don’t need to interface with a bank to use a stablecoin, you just need to acquire it on the open markets and receive it on an on-chain transactions. 99% of stablecoin transactions don’t involve facing off against the bank directly, or against the issuer. So they are kind of less encumbered than commercial bank relationships, and I know people talk about the freezing possibility. Tether has frozen a couple hundred addresses in its history. USDC has frozen a small handful. So that does happen, but it’s nowhere near as pervasive as deplatforming from the financial system. So it’s certainly not as censor-resistant as Bitcoin. Now there are stablecoins you can look to which probably have slightly better censor-resistant qualities like DAI, which is built against crypto-collateral and—in theory you could do the same with Bitcoin! You could probably figure out how to build a stablecoin using DLCs or other smart contracting technologies to build a dollar-denominated asset which is backed by a basket of Bitcoins, which would also be pretty trustless. And I expect someone to make that in the next year or so. So even within the stablecoin space there’s a bit of nuance in terms of the settlement assurances you have.

Stephan Livera [20:01]: Yeah that’s an interesting idea there as well. I recall from one of my relatively recent episodes with Nadav Kohen from Suredbits, he spoke about exactly that kind of idea: using discrete log contracts to do a similar kind of thing with Bitcoin. One other point I wanted to touch on was around the compliance aspects. So you were mentioning there: usually AML laws and sanctions laws that we’re talking about here—and to be clear, one of them is Politically Exposed Persons — so that’s where there’s whole idea of, if you’re a politician or you’re a senior level bureaucrat or something and then your family might be also implicated in that. But with stablecoins it’s more like, the compliance seems to be occuring at the entry and the exit points, and once you’re kind of inside that system it seems to be more of a freewheeling system, wouldn’t you say?

Nic Carter [21:04]: Yeah. Anybody that looks into stablecoins long enough eventually has this realization, and it’s like, Oh wow! This is actually a little bit different from the way that the financial system works. Or even something like PayPal, right? Pretty much every single transaction on PayPal contains metadata and identity information. And PayPal has the right—and they take advantage of this — to freeze any of those transactions. In fact, I sent a joke PayPal transaction to my friend Neeraj of CoinCenter, and I think I made the memo field something like “North Korea” and like “Persian Rugs” just to see what would happen, and they froze it!

Stephan Livera: Ha ha, you were trying to get his account cancelled?

Nic Carter: Every single transaction in most mainstream FinTech apps is effectively surveilled, or risk analytics are being run against them. Now in stablecoins, as you say, those egress and ingress transactions where you are creating or redeeming stablecoins, there’s KYC involved there. But on the internals of the transaction graph, those transactions that are actually ocurring on either Bitcoin, on the OMNI protocol, or on Etheream as ERC-20 transactions, or even on TRON which is popular for stablecoins for some reason, those P2P transfers are really not meaningfully being surveilled. There’s not a lot of identity information that can be associated with them, because it’s pseudonymous. So on the internals of the transaction graph you have a situation where it much more resembles actual digital cash, in the same way that physical cash transfers do not carry any surveillance. And basically, P2P stablecoin transfers, on-chain, much more closely resemble physical cash transactions, and they have less in common with these transactions on these digital payments networks that we’re used to. And it’s kind of a startling realization. JP Koning, who is not a Bitcoiner but he writes fairly intelligently about payment networks, has called this the permissioned pseudonymity model, and it’s honestly a really big outstanding question whether the state or regulators are gonna take a look at this and realize what’s going on and say, Okay, we’ve got to put an end to this!

Stephan Livera [23:32]: Yeah, that’s an interesting question, because, if they allow this to carry on, well then, it just kind of helps this overall greasing of the wheels, if you will, in and around the exchanges of the space. And so, it allows all sorts of hack workarounds in some ways. Whereas, if they do clamp down harder, then obviously it becomes more difficult for people to get money in and out of exchanges and move it around, and do all of these other on the side things, and other services that are operating on a more stablecoin basis, like stablecoin lending and so on.

Nic Carter [24:14]: Yeah, and I honestly don’t know how regulators would build regulation into stablecoin networks. Fundamentally, we’re talking about blockchains which are pseudonymous. I’m not sure how you would try and inject identity information. Currently stablecoin issuers operate on a blacklist model, where they will blacklist certain addresses and freeze those funds if, for instance, they get a subpoena from law enforcement that says, Hey, this is an entity that hacked an exchange — could you immobilize these funds? But you can’t transition that really easily to a whitelist model where default node transactions are permitted unless you make yourself known to the issuer. The whitelist model would just make these networks not work. So I don’t know functionally what it would even look like for regulators to even grapple with this.

Stephan Livera [25:16]: Yeah. I guess that’s a tougher one to answer. I would also like just get a bit of context around the volumes that we’re talking about here. What kinds of volume are we looking at in terms of stablecoins versus, say, Bitcoin volume?

Nic Carter: Currently, collectively, all of the stablecoins will do about $5 billion worth of settled value every single day. So, pretty meaningful — it’s up from effectively zero a couple years ago. Now Bitcoin is doing also about $5 billion of settled value per day. Now the thing to note though is that Bitcoin’s aggregate market cap is north of $300 billion. The aggregate market cap of stablecoins is closer to $25 billion, so you can see that stablecoins have a much higher velocity. They’re turning over more frequently, whereas Bitcoin has a much slower velocity. So what this tells us is that they’re doing roughly equal amounts in terms of settling value every day, but stablecoins are doing so with the whole supply turning over more frequently, which shows that they’re being employed more as means of payment, whereas Bitcoin is this more slow-moving wealth storage mechanism.

Stephan Livera [28:38]: Okay, so that’s around the volume of stablecoins in relation to Bitcoin. I think it’s also a good point now to explore the bull and bear cases for stablecoins, and whether they are bullish for Bitcoin or bearish for Bitcoin? Do they work with it or are they in some way detracting from Bitcoin demand? Now I know you are more on the bullish side, but let’s’ first explore some of the bearish arguments, right? So maybe one of the bearish arguments would be, Oh, it’s detracting from Bitcoin demand! Some people might just stay in stablecoins rather than using Bitcoin. What do you think?

Nic Carter: Yeah. Honestly that’s already happened to a certain degree. If you look at exchange volumes, if you look at the pairs that are traded globally, if you look at exchange reserves, you notice that a lot of these—what would formerly trade against Bitcoin—all these exchanges with altcoin pairs and derivatives with Bitcoin being the more popular asset, either the base pair or the quote pair. I’m forgetting which one it is. Bitcoin was the de facto reserve asset of the crypto industry from the inception, right? And over the last couple of years, many exchanges becamed Tetherized, so Tether became the base pair, and all of these markets were expressed in Tether terms, and the main collateral that was held on these exchanges was Tether, effectively. So you had some purist exchanges—like BitMex, they were a purist exchange. They never had any stablecoins on there. The only way to get collateral on the exchange was on Bitcoin terms. But, you know, now they’ve shrunk a little, and other newer exchanges like ByBit and FTX, they all use Tether as the main form of collateral, and the main way to make a deposit, and a lot of them quote their markets in Tether. So this has actually already happened! But what’s interesting is, here we are, back at all time highs for Bitcoin. So this kind of implies that, Yes, some of this reservation demand for being the reserve asset for altcoin trading and for derivatives trading, some of that reservation demand was effectively removed and was moved into Tether, basically—and other stablecoins, right? But this hasn’t really affected Bitcoin! Bitcoin is still fine! So it’s just the nature of Bitcoin that’s changing a little bit, it’s more of a global macro asset. It doesn’t necessarily need that reservation demand. But yes, unambiguously I think exchanges getting Tetherized did remove a certain reservation demand from Bitcoin, and probably had a bit of a price impact. It’s impossible to quantify. The ultimate question is, Can stablecoins sustain this indefinitely? And I would probably argue, No, I don’t think they have the same characteristics as Bitcoin, because stablecoins are ultimately someone’s liability. They’re a liability of an issuer, in most cases, of a commercial bank. And that’s not a great property to have for a monetary good! Pure monetary goods like gold and Bitcoin are no one’s liability. Their value comes not from someone else promising to back it, but the value is solely market determined, which is the case for Bitcoin. So ultimately, the true reserve asset, the true monetary base asset at the base of that pyramid — you do want it to be something that’s trustless collateral, which stablecoins are not. So I don’t think they can ever really fully replace Bitcoin as that key high-powered collateral.

Stephan Livera [32:32]: Yeah. I think that’s really nicely put, because ultimately they’re not monetary competitors with Bitcoin in the longer term sense, they are just more like a helping tool or a bridging tool that people are using in the here and now. And also, to the point about volumes and sizes, obviously there’s this whole canard that seems to come up from some people who are not that familiar with what Tether is and what some of these stablecoins are. The typical argument is, Oh, see! Bitcoin is being pumped by Tether! What do you think on that kind of argument?

Nic Carter [33:11]: Yeah. So I’ll go on the record here, I don’t know if I’ve ever really addressed it on a podcast before. Yeah I’d love to see some evidence of that. I think the onus and the burden of proof is on the people making the positive claim. All the proof I’ve ever seen, all the evidence—talking to traders that have created hundreds of millions, in some cases billions of dollars worth of Tether — is that there is a counter-party there, they are using bank wires, they’re using real fiat currency through the commercial banking system around, to create and redeem Tether! And I am not a Tether user, I personally have never used Tether, but I had Dan Matuszewski on my podcast a while back, and he told me that when he was at the Circle OTC desk they created billions of dollars worth of Tether, and that’s with bank wires! So that’s taking real dollars and wiring them to the counter-party and getting Tethers against those dollars. And then redeem them on the other side. That’s all consistent with Tether being, at least in some sense, a real thing. Now obviously it’s impossible to ascertain the reserve quality, and that’s a huge shortcoming which I totally agree should be addressed. And I’d love to see more transparency behind all of the stablecoin issuers, not just Tether. It’s actually hard to get good reliable information on the quality of the reserves, for even the on-shore US based stablecoin issuers. But now this notion is taken a little bit further—which is that Tether is somehow responsible for the price of Bitcoin — is just preposterous to me! There’s one study from Griffin and Shams, which relied on timing analysis, and they found that, during periods when Tether was being issued, Bitcoin’s price rose in those periods, which is — you know there’s so many alternative explanations that aren’t consistent with Tether somehow buoying the price of Bitcoin. The obvious alternative explation is, Well, traders were engaging in dip buying, and they used Tether as a conduit to get into crypto exchanges, get into crypto liquidity. It’s no coincidence that Tether issuance was happening at the same time as they were placing their buy orders, because they were using those Tethers to subsequently buy Bitcoin. So, there’s very simple alternative explanations there. The other thing is, part of their paper relied on this analysis of looking on-chain and seeing when there are high periods of on-chain volumes for Tether and finding that that correlated with Bitcoin price increases. But the other thing to point out there is, price increases are synchronous and coincident with high on-chain transfers, just by their very nature, because when price is going up, there’s a lot of activity. Those arbitrage funds kick in to high gear. So that’s also something that can be very easily explained. Look, I’m not gonna deny that Tether could be doing a much better job of their transparency, and at this point they’re systemic to the whole crypto industry. So, like many others, I would love to see more transparency from them in their reserve quality. But I’ve also never seen any direct evidence whatsoever, that Tether is somehow either unbacked or, more perniciously, being used to inflate the price of Bitcoin, which makes no sense. I mean, if you’re Tether, and you could magically inflate the price of Bitcoin by printing unbacked Tethers without the market ascertaining that, what’s to stop you printing the price of Bitcoin arbitrarily high? Why, in that case, are we only at $19,000? Why aren’t we at $300,000? You know? The critics don’t really have a plausible story to tell here. The other thing I’ll mention is that there have been subsequent analyses that have focused on the same Griffin and Shams paper and have found no direct effect between Tether issuance and the Bitcoin price. One was by Viswanath-Natraj. The academia isn’t settled on this topic, either.

Stephan Livera [37:43]: Yeah. Just a historical comment: it seems that every run seems to have it’s own little story as well, right? So 2013 it was Mt. Gox and the Willy Bot. And then in 2017 the story people have is, Oh! I see it was pumped by Tether! And then so even this bull run, you’re hearing some people saying, Oh! See! It’s GBTC! Right? We tell ourselves these little stories, but those aren’t necessarily the full explaining factor.

Nic Carter: Yeah. The other thing to note is that Bitcoin was roughly flat for a long 2-year period here, if you measure from late 2018 to earlier this year. Whereas Tether was increasing by a full order of magnitude. It went from a couple billion in late 2017 to $25 billion today. So for a long period where Bitcoin was trading sideways, more funds were getting onshored onto Tether, partly due to this replacement that I mentioned, where Bitcoin ceased to be the crypto reserve asset, or lost some of its qualities as the crypto reserve asset. So Tether was increasing by hundreds and hundreds of percent, but Bitcoin was flat during that time, so that’s completely inconsistent with this Tether inflates Bitcoin thesis as well.

Stephan Livera [39:12]: Right, I see. If I was to put on my Peter Schiff or Nouriel hat, they would say, Oh! See! They were just trying to pump it so hard! And they needed to keep making all these Tethers to even try to keep it the same! But I think, at some point, you’re just never gonna convince some people, so you just have to let them wait until they’re comfortable to actually see Bitcoin for what it is.

Nic Carter [39:35]: Yeah. People like one-dimensional explanations for price action. Nobody seems comfortable with the fact that Bitcoin is just undergoing this process of monetization and waves of adoption, and that’s a fundamentally random process in terms of how the key variables interlock, but it’s also just a long term secular process of growth! Rather, people would instead lean on these incredibly simplistic explanations of insidious market makers somehow manipulating the whole market and manipulating price upwards. They can’t find it in their souls to believe that Bitcoin is just this newly monetizing monetary commodity. That’s too difficult or complex of an explanation for them.

Stephan Livera [40:30]: Yeah. Perhaps at some level they’ve already committed their minds in a certain direction and now to turn around and go back, maybe that’s just difficult for people to do or maybe they feel that would make them look weak or whatever. One other point that you brought up there recently is systemic risk and blow-up. That could potentially be another bear case for stablecoins in terms of Bitcoin impact. If one of these big ones—for example Tether, or one of the other ones — if there were to be some big systemic blow-up, could that look really bad for the ecosystem?

Nic Carter [41:09]: Yes, it could. And I think the big casualty would actually be longtail altcoins, which trade exclusively against Tether. A lot of these marketplaces and exchanges don’t have connectivity to a fiat system, and in fact the reason they’ve been able to emerge is because stablecoins exist, right? So once stablecoins were in place, this new set of altcoin exchanges could emerge. And they have done so. They would be the big casualties if Tether blew up. And that would eviscerate the liquidity for a lot of longtail alts that are traded only against crypto-pairs. They’re no fiat pairs for those altcoins. So they would be the big casualties in my opinion. Now the effect on Bitcoin is more mixed, and I think what is very possible is that there would be an inflow of funds back into Bitcoin as a kind of safety net, because if it emerged that Tether was insolvent or not fully reserved or something, what are traders gonna do with the Tethers that they hold? What is the most liquid pair that Tether is traded against? It’s against Bitcoin! So I think that’s where they flee! It might be more challenging for them to flee back into their sovereign currencies and they may not want to do that. So I think they flee into the alternative crypto reserve asset which is truly liability-free, and cannot be impaired by a lack of reserves, the same way Tether can be. So my guess is if anything happens to Tether, a lot of capital is gonna flow back into Bitcoin as safety net, the same way that you have a global risk-off even in regular capital markets, and capital flows into US Treasuries, which is considered the safest and most liquid asset. So I would say there is the potential for it to actually cause a huge capital inflow back into Bitcoin. And we’re talking about roughly $20 billion worth of Tether, so it’s a really material amount. So bad for crypto markets generally, but potentially good for Bitcoin as this liability free base asset.

Stephan Livera [43:24]: That’s a really great way to put it! One other kind of bearish argument — but it’s not exactly — it’s more just about, there’s different platforms, and we’re taking different kinds of technological risk when we use them, so obviously things like, if you use some coin that is really centralized as a platform, then is there a risk that some rollback changes things for you, or that potentially it is more amenable or more likely to get shut down, or to go down under its own steam? And then the stablecoin people are left holding a bag if they’re using an altcoin platform to do that stablecoin with. Do you have any thoughts on that, and how the market participants are evaluating that risk?

Nic Carter [44:17]: Yeah. I don’t think they’re evaluating it, Stephan, to be honest with you. The most number of Tethers that ever existed on Bitcoin was about $3 billion. Now, on TRON, there’s double that today: there’s $6 billion worth of Tethers that circulate on TRON, they’ve got a fixed validator set and it’s pretty centralized in terms of the node validation and the consensus formation, right? I don’t think it’d be that difficult for a highly motivated state actor to interfere with TRON if they wanted. But you have more Tethers circulating on TRON, lots more, than ever circulated on the OMNI protocol on Bitcoin. And on Ethereum, you have over $12 billion worth of Tether, and you also have billions of dollars worth of other stablecoins on Ethereum too, like USDC. There’s another $3 billion of USDC on Ethereum! So I think the entities using Tether, they kind of just take it as a given that the blockchains that they circulate on are just gonna function well in perpetuity. They don’t seem too concerned about it, and they switch between them all the time. What they do is they use these exchanges as these hubs to switch between Tether Bitcoin, Tether Ethereum, and Tether TRON. So they switch between them seamlessly. It seems like traders treat it as the same asset regardless of the actual blockchain infrastructure that it’s circulating on. But yeah, it seems to me that people aren’t really concerned with the underlying infrastructure, and maybe they feel that if something were to go wrong, then the ultimate ledger would be managed by Tether itself, and effectively Tether maintains an off-chain ledger of their own, where they can step in if something goes terribly wrong.

Stephan Livera [46:26]: I see. So at the end of the day, these things are just far more centralized anyway, so most people are just gonna — the participants in the market are relying on that as their get out of jail free card if something were to blow up with TRON or Ethereum and so on?

Nic Carter: Yeah I think so! And people already appeal to Bitfinex and Tether when something goes wrong with Tether, and this is another thing: when you see exchange hacks. Now the fact that some of these stablecoins have this reversibility—which is a bug in my opinion, but on stablecoins it’s treated as a feature—this reversibility allows for the undoing of some negative events. So Tether has already begun to play that role.

Stephan Livera [47:12]: Yeah so I guess we can say, Well, look. These are more openly centralized. And so even in the case of a blow-up, they’re just more centralized anyway, so it’s just not gonna — hard to go from there. Those are the main bear arguments I can think of. Actually, are there any other bearish arguments while we’re here, before we go on to bull arguments?

Nic Carter: Yeah, and this is very salient to our current discussions: the other thing is that, if you talk to a central banker about the cryptocurrency space, and you ask them, What are you nervous about? They will almost always say stablecoins! They typically don’t say Bitcoin! I don’t know if this has been your experience as well? But it’s certainly the case with me. Central bankers are fixated on stablecoins, and really, Libra is actually the one they care the most about. But increasingly, also, the stablecoins that exist on-chain. So stablecoins have catalyzed a lot of keen investigation on the part of central banks and financial regulators into the crypto space, and they could be the element of this industry that actually gets governments to care about it, and attempt to crack down on it. Because all of these central bankers are pretty afraid of — not necessarily Bitcoinization — but involuntary dollarization, whereby they lose their monetary privilege, because stablecoins become so frictionless and easy to acquire that there’s a currency substitution that occurs in their country. And for sure this is something that’s happening in Venezuela today, it’s happened historically in Equador — not with crypto rails, of course, but with physical dollars — so it’s not too far-fetched to think that this totally is possible. So the way that that could affect Bitcoin would just be by causing a regulatory hammerblow to fall on the industry. Now I think that we all expect and hope that Bitcoin is sufficiently robust that it can deal with that if the time comes, but that’s another part of the bear case is that the stablecoins provoke governments into cracking down pretty hard on the industry.

Stephan Livera [49:36]: Yeah that’s a good point. And so, just to clarify there, in some sense, the US government is kind of happy that more people are gonna use the US dollar, right? It’s more other countries who are gonna be unhappy about, basically — historically, you had to use physical cash to try and US dollarize, but now that people can do it with stablecoins, that makes it more of a risk for them, and if you’re the Venezuelan government, that’s why it’s more of a concern for you, right?

Nic Carter: Yeah exactly, it’s just easier to dollarize on public blockchain rails, and so potentially it could happen more aggressively. On your question about the US government I would say it’s a little more nuanced. I mean, the government does issue the world’s reserve currency and they wield strong benefits from doing that, but they don’t want dollars to be percolating out into the world through a means that they don’t control. And currently they don’t control stablecoin infrastructure. You know, it’s run as a protocol by a bunch of nodes. And so, that’s also part of the reason we’ve seen a bunch of policymakers in the US express their misgivings about it, even if it is effectively adding demand to the dollar, and potentially exporting the dollar overseas. It’s doing it in a way that’s outside the New York based correspondent banking system, outside of their surveillance apparatus. So, my guess is that they’re actually not too happy about it, all things considered.

Stephan Livera [51:11]: Right. And it may be different regulators in different parties who have different concerns. And so the ones who are more concerned at like, say FinCEN, might be more concerned because they have less visibility into their whole financial surveillance network. So let’s bring it to the bull arguments then. So the bullish case for stablecoins in terms of their impact on Bitcoin. I guess the main one that I can think of is just that it helps the overall liquidity and greasing the wheels for people to move through the exchanges and through different, other businesses and products and services that can be built using stablecoins that weren’t otherwise possible with Bitcoin. What’s your view on that kind of idea?

Nic Carter [52:04]: Yeah, so that’s undeniably a positive for Bitcoin. Just more liquidity, better connectivity between exchanges. So if you’re [into] dislocations and into exchange prices — the existence of stablecoins mean that these arbitrage funds can operate in a capital efficient way, which is good for Bitcoin liquidity. I would say that that’s the number one way. But the number two thing I would point you to would be, stablecoins might be penetrating a global audience of potential Bitcoin adopters before they have the experience of using Bitcoin. So, right now, the first experience most people have with cryptocurrency is with Bitcoin. And that’s kind of been the default way that people get exposure to storing cryptographic information, storing value in the form of key pairs. And getting used to that concept. But it could be the case that, in a couple of years time, the default that people would get exposure to this concept — this is a transition that people need to go through: understanding information as value. We’ve never really had to deal with that before. The default way they might do that would be through a stablecoin lens. Bitcoiners might not like hearing that, but it’s totally possible in my mind, that that’s the more immediately addressable way that people get exposure to digital assets, basically. And I think that could actually be an accelerant to the whole concept, and let people go through that learning experience, and then when they’re ready, they could level up and then go to non-state monetary assets like Bitcoin. I think that’s another way is that it penetrates a slightly different niche. It’s people that maybe want dollars, and they’re willing to consider this alternative infrastructure for those dollars, and once they’re onboarded onto that and they’re mentally ready, then they can make the leap to Bitcoin. So that would be the second way I think it could be really positive for Bitcoin. The third thing, and this is already a feature of the market, is that stablecoins only exist because of Bitcoin, and a lot of these stablecoin pairs are only liquid in a lot of these markets also because of Bitcoin. There’s plenty of stablecoin usage in Venezuela, but that market was bootstrapped by the LocalBitcoins peer to peer market, where Bitcoin was obviously the main asset. So Bitcoin is this kind of non-state asset which is available globally, permenantly. It’s the asset against which stablecoins trade most of the time. So Bitcoin is the true, ultimate clearinghouse of value, and then stablecoins are trading against Bitcoin. So it gives stablecoins a liability-free pair to trade into, and the way I see it is, we’re getting progressive waves of regulation here, and so the popularity of stablecoins is gonna rise and fall over the years as regulators get more and less onerous. But Bitcoin will always be there, and at the times when nation-states are more hostile to stablecoins, more value will flow back into Bitcoin. And then as things open up again, some value will flow back into stablecoins, as the perceived risk declines. And so I think you just get this back and forth, but the constant is that Bitcoin is always gonna be there as this capital sanctus, to satisfy this demand, and to be this monetary constant, with stablecoins waxing and waning around Bitcoin. So it’s a difficult concept to express, but Bitcoin’s permanent presence in these markets is what permits stablecoins to work. So stablecoins certainly need Bitcoin. Bitcoin doesn’t need stablecoins, but I think it certainly benefits from their existence.

Stephan Livera [56:15]: Yeah, very interesting argument. So essentially you’re saying that they have some kind of a symbiotic relationship. They’re both benefiting from each other!

Nic Carter: Absolutely! And the thing I didn’t mention is that I believe that stablecoins will be issued against Bitcoin in the future. And we probably aren’t going to have to wait that long for that to happen. There are already stablecoins being issued against spot Bitcoin, where you short Bitcoin, and you have a spot long position, and that bundle of the two creates a dollar-stable position. So that’s one way that some people are creating a stablecoin against Bitcoin. But you could also do it in a Maker style, and there’s no doubt in my mind that the smart contracting ability in Bitcoin is gonna progress in the future to a state where it’s totally possible to build the equivalent of Maker on Bitcoin. And then we’ll just take the most successful concepts in DeFi and apply them to Bitcoin in a trust-minimized way. And if you look at DAI, DAI is one of the most popular stablecoins on Ethereum. It really punches above its weight in terms of its philosophy. So I think the Bitcoin equivalent would also be pretty popular, honestly. A Bitcoin-native dollar-stable asset, facilitated and issued against Bitcoin collateral — I think that is a good idea. And so I do expect that in the future, Bitcoin will be a reserve asset for the issuance of stablecoins, and of course that will increase the reservation demand for Bitcoin. So that’s kind of the final thing: stablecoins are strong evidence of the fact that people desire dollar-denominated liquidity on-chain. And they’re willing to issue it against crypto-collateral. And I think Bitcoin is obviously the best form of collateral on-chain, because it has the best volatility characteristics and it obviously has the best monetary characteristics. I do think that it’s gonna be another way that proves out the value of Bitcoin as this base monetary asset.

Stephan Livera [58:29]: So, taking that as a given then, is there an implication there in terms of the kinds of software and Bitcoin wallets that people should be using? One example I can think of right now, Blockstream Green: you can have liquid Tether on there and you can have Bitcoin on there. Is that a scenario that might play out over the next few years, where there might be some people who come into just having some Tethers in a phone wallet, and then eventually they start seeing, obviously, Number go Up, and then they start thinking, Oh! Hey! Why am I holding this USD Tether thing, I can hold some Bitcoin as well! Do you see that as a plausible story? Or as a potential method that software and Bitcoin wallets should be built out in?

Nic Carter [59:15]: Well, I’m not gonna prescribe any behavior to wallet developers. They definitely understand their users far better than I do. But there is something very convenient about multi-asset wallets, especially Blockstream Green — great, great example. I hear Liquid mentioned all the time in terms of more sophisticated, complex smart contracts on Bitcoin. I expect that some of the first stablecoins issued against Bitcoin will be Liquid assets, that exist on the Liquid sidechain. I also think we’re gonna get a flavor of wallets that give you options in terms of de-risking your Bitcoin position, so maybe you’ll be able to flip a switch and change your Bitcoin position to being market-neutral, and effectively flat in dollar terms. And maybe behind the scenes, there’s some complicated on-chain derivative transaction that is going 1x short on that Bitcoin, and so you’ve created an effective stablecoin against Bitcoin collateral. Those are the kind of things that are possible with more development, especially in the DLC space. I think Taproot is also gonna give us some more tools to do this. I don’t know exactly what it’s gonna look like, but I have no doubt in my mind that smart developers are gonna figure this out and we’re gonna have a much broader arsenal of risk-management products that are native, on-chain, Bitcoin-based, and trust-minimized.

Stephan Livera [1:00:46]: Yeah that’s a really interesting vision that we might see with a kind of Bitcoin DLC wallet enabled vision there. Or a similar idea I guess. One other topic that I think we obviously should hit as well, which is stablecoin regulation. Recently there was this whole blow-up on Twitter about the Stable Act. Can you tell us a little about, first of all, what is that, and then what was your reaction to that?

Nic Carter: There’s a lot of interpretations and authors of the Stable Act have done themselves no favors by spouting off on Twitter which really muddied the waters, honestly. The Stable Act at its core basically says: stablecoin issuers need banking licences to operate. And their interpretation of stablecoins is that, these issuers are engaged in a banking depository style activity, and as such, they should be regulated by the state as banks. And anybody that understands what it’s like to get a bank charter knows that this is an absurd proposition, because bank charters are incredibly difficult to come by, they require something like $20 million in paid up capital. Nobody gets bank charters anymore, at least in the US. The number of banks that exist just continues to decline year after year, and there’s really been a stark decline in the number of banks in the US over the last 40 years. What this really is, is an attempt to nationalize a private sector industry which has been doing really well! And I’m ultimately sympathetic to the core idea, which is: fiat-backed stablecoins should be more transparent about their reserve quality, and they should give depositors assurances that the stablecoins are actually backed on a one-to-one basis with actual dollars in a bank account. I’m totally sympathetic to that idea, and it should be the case that there is some mechanism for them to prove that. I would be in favor of something like the FinTech charter — which Brian Brooks proposed — which would be a modified bank charter which takes note of the idiosyncrasies of the FinTech provider. Or something like an expansion of the special purposed despository institution, which is really suited for stablecoins. SPDIs in Wyoming, they are only entitled to hold a full reserve of the asset that they’re custodying, so they can’t operate fractionally. That’s kind of what a stablecoin is! Stablecoins are meant to not be fractionally reserved, they’re meant to be fully reserved. So there are a lot of interesting proposals for alternative bank charters. But the problem with the Stable bill is that it was just trying to treat these things like actual, regular commercial banks that engage in maturity transformation and engage in lending, and are heavily regulated as a consequence. But stablecoin issuers don’t do any of this stuff! They just immobilize deposits in commercial banks and they issue IOUs that circulate on-chain against those deposits that are convertible for them. So the instrument that is being proposed—as the solution to this issue of auditability — is an incredibly blunt and ill-fitting one, in my opinion. So that’s the problem with the act, in my opinion. It takes this really archaic view of stablecoin issuers as banks, and tries to force them into this template, which basically makes no sense.

Stephan Livera [1:04:26]: Yeah. And so it seems that the creators of that, and the advisors of that maybe, are not as familiar with how Bitcoin and this world works. But from what I’ve also read of the analysis from Coin Center and also Preston Byrne’s analysis, it seems as though this particular bill is unlikely to actually get passed and become law, but it seems that this is now the — they’re on this path and they’ll probably keep trying, won’t they?

Nic Carter: The odds of any proposed bill of being passed is vanishingly low so you do have to contextualize it and look at, Well where are we in the cycle? What’s the political trends here at play? Currently we actually have a split chamber, right? The Senate is Republican, and the House is Democratic, so I doubt there’d be bipartisan unity on this topic. And also we have allies in the Senate and the House now. I think it’d be unlikely for something like this would pass now. It’s actually more broad-reaching in the language in the bill than just stablecoins. It would actually affect FinTech providers like Venmo, PayPal, any e-wallet where you can hold a balance. They would all be considered stablecoins under this bill, which is preposterous! It’s an abuse of language! Nobody refers to those things as stablecoins. You don’t say, Send me a $10 stablecoin transaction on Venmo, you just ask for your friend to Venmo you. The bill is authored in such a way that it would actually captural all of this activity under a broad net so it’s just a poorly constructed bill.

Stephan Livera [1:06:16]: I think some of the other lawyers in this space have spoken about how there are already a range of compliance issues with some of these stablecoins anyway, so if government and regulatory agencies wanted to come after them, they could use the already existing laws and try to clamp down in those ways, and apply other kinds of AML whitelisting or other kinds of controls, or try to force that square peg into the round hole, couldn’t they?

Nic Carter: Yeah we don’t necessarily need new laws on stablecoins. Although various legislative bodies are proposing them, not just in the US. I would say it would be welcome to have a specific kind of bank charter, which would be useful, which would suit stablecoin issuers. Because right now the way they’re regulated is: they register as money services businesses with FinCEN, and that gives them obligations around money laundering, AML and KYC, and then they typically have to go after money transfer licences in a bunch of states. And that is not a homogenous regime. The process of getting those licences on a state by state basic is pretty onerous and the states aren’t necessarily the best regulator for what those issuers are doing. In my view stablecoins are effectively narrow bank or money market mutual funds. They should probably be regulated as such. Look, I’m not calling for more regulation, but if there is a regulatory instrument that’s created, it should just be mindful of the way they actually operate and not treat them as banks, which they really are not!

Stephan Livera [1:08:09]: Stepping back a little bit more broad: what’s your view on stablecoins over the next 5 years? Do you think they’re gonna wax and wane through these cycles? But it sounds to me like your view is fundamentally bullish stablecoins, but in a way that’s also bullish Bitcoin?

Nic Carter: Well the demand for stablecoins has obviously been proved out this year. I mean we went from $4 billion in outstanding stablecoin float to start the year to $25 billion today, which is just unbelievable! It’s just unbelievable! I mean, those numbers in any other context outside the crypto industry would be eye-watering. So there’s no question that people want dollar-denominated liquidity on largely censor-resistant blockchain rails on a globalized format such that you can hold those coins in your own possession with a private key. So digital bearer assets, cash-like digital bearer assets, there’s no doubt in my mind that there’s huge demand in the world for that. Now the big, big question is, is the hammer gonna fall on the likes of Tether and maybe even USDC and all the other issuers? Are the regulators gonna get their way and come down on the issuers? If that’s the case, the only stablecoins that’ll be left will be the crypto-collaterized stablecoins like DAI, which are much harder to regulate against, because they are just created through smart contracts, as opposed to traditional commercial bank relationships. So there’s one scenario where, there are adverse regulatory outcomes for stablecoin issuers, and the only model that really survives is the crypto-collateralized model. And then there’s another scenario where stablecoin issuers continue to exist in this grey zone, and continue to be reasonably private and reasonably censor-resistant albeit not perfectly so, and they just keep growing. But I do wonder what is the end state of that? The only thing that constrains their capacity is the balance sheet of the commercial banks that are holding the reserves. But that is almost unbounded. So what happens if you get to $200 billion in stablecoin prefloat? There’s probably a point where it becomes systemic and where bank regulators worldwide try to triangulate the banks that are holding reserves for these things. So I don’t think that it can grow indefinitely. I do think that there is a Sword of Damocles hanging over at least the stablecoin industry in its current format, absent of any regulatory clarity. I don’t have a firm answer on it, but I do feel that we’re waiting for a hammer to fall which hasn’t fallen yet! I don’t know what form it’s gonna take. I don’t think Tether for instance can exist sustainably for the next 5 years.

Stephan Livera [1:11:17]: I see. So the fiat backed stablecoin phenomenon may be a short or medium term one. And then potentially maybe putting on the optimistic for Bitcoin hat, people work on some kind of DLC version of a Bitcoin stablecoin, and then, if there’s a crackdown from a regulatory view on the fiat-backed stablecoin style, maybe that’s the stress to the system that causes the adaptation of the Bitcoin style stablecoin?

Nic Carter: Yeah that’s very well put. I think that’s very, very plausible. I do think that the more truly cypherpunk stablecoins that are issued in smart contract form against liability free collateral — those are the best ones! Those are the most robust ones. And they’re the ones that are most likely to last the longest. The fiat backed ones are fragile, so they can pop out of existence at any minute. Regardless of the regulatory winds at play, we’re gonna figure out how to create stablecoins on top of Bitcoin, and I think they’re gonna be a hit, honestly! I think they’re gonna be a hit! So I’m pretty excited to see how developers figure out how to do that!

Stephan Livera: Fantastic! That’s probably a great place to leave it, but of course before we let you go Nic, where can listeners follow you and find your work online?

Nic Carter: I’m not hard to find! Number one place is on Twitter: @nic__carter.

Stephan Livera: Fantastic! And I’ll include the links in the show notes. Nic, thank you again for a very enjoyable discussion!

Nic Carter: Thanks Stephan! Thanks for having me on again!

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