Gu Yanxi: How to issue stable currency based on Bitcoin?

The emergence of the Libra project has increased the market focus of stable coins by an order of magnitude. This project not only forces global financial regulators and central banks to formulate corresponding countermeasures, but also stimulates the enthusiasm of stable currency products in the market. Due to the large scope of the Libra project, there are huge risks in all aspects, and there is a great uncertainty in its future. But Libra's design and promotion experience will certainly be used for similar projects in the market. There will be a stable currency project in the market where design is more reasonable and application promotion is more feasible.

A few days after the publication of Libra's white paper, I published a research report ( Libra project research analysis report ) that a very likely way to generate stable coins is based on digital asset collateral and distributed. The way it is produced. I will elaborate on this mechanism for generating stable coins in a separate article ( How to create a new stable currency that competes with Libra? ). However, the current scale of digital assets based on physical assets and equity is still very small, so the practical application of this stable currency generation mechanism is still far away. In addition, whether a stable currency can be promoted and applied in the market depends on many factors, and a reasonable production mechanism is only one of them. Some other more important factors include the positioning of the stable currency and the application scenario. Due to the development of blockchain technology and encrypted digital assets, the technical cost of issuing digital stable coins is very low, and various stable coins have emerged. More types of stable coins will appear in the future. The product design and market positioning of stable currency products are therefore as important as the technical production mechanisms and financial attributes of stable currencies. In this respect, the stable currency is the same as other product promotion mechanisms ( so many public chains, so few applications ).

At the current stage, a very viable coinage method is based on Bitcoin issued stable currency. If the coinage mechanism is properly designed and positioned correctly, the stable currency issued in this way will be properly applied at present.

1. The current value base and circulation system of the currency


In most historical periods of human life, gold was used as currency. The basic characteristics of gold are limited total stock, very fine segmentation, very long life and easy portability. These characteristics make it a value carrier and a means of value circulation. In the modern economic life, there has been a currency linked to gold. The Bretton Woods Agreement establishes a link between the US dollar and gold. The world uses the US dollar as the currency of circulation. Due to the development of electronic technology, in addition to the existing currency and coin circulation methods, the currency can be circulated by electronic accounting. The value of the dollar is anchored with gold, and the medium that supports its circulation is banknotes, coins, and electronic bookkeeping. This new flow of methods is more conducive to the circulation of the US dollar on a global scale.

The US government spent a lot of money during the Vietnam War. To cope with such spending, the US government printed a large amount of dollars. This has resulted in the dollar price not being able to continue to be linked at the price determined by Bretton Woods. Nixon was forced to announce in 1973 that the dollar was decoupled from gold. Since then, the dollar has relied on the US government's credit issuance, and is no longer a gold standard currency.

Second, the coin-based model based on digital assets


The current representative project for generating stable coins based on digital asset collateral and distributed methods is MakerDao. MakerDao is secured by Ethereum. The market trading price of Ethereum is the value base of this stable currency DAI. MakerDAO automates the entire coining process with smart contracts. The mortgage assets that users use to mint coins are hosted on Ethereum. There is no human intervention in the entire coinage process, which is done entirely through smart contracts. This coinage process is completely decentralized, which is completely different from the previous centralized coinage process and is an essential change in the coinage process. But the limitation of the MakerDao project is that it only supports coinage based on Ethereum. The underlying assets are limited, so the number of stable currencies that can be issued is limited. Most importantly, some of the basic elements of this coinage mechanism are unreasonable ( analysis of the 'most promising' stable currency project MakerDAO ), so the MakerDao project is difficult to support the release of a large number of stable coins.

Third, bitcoin-based coinage mode


Nakamoto's original intention was to design Bitcoin as a digital currency. But because of the design of Bitcoin itself, when it began to circulate in the market, it did not become a digital currency, but became a digital asset. Its value is formed through 7*24 trading in exchanges around the world, and is the result of market consensus. This way of value consensus is therefore more objective than the current method of determining the value of real estate and company stocks. The only difference is that bitcoin is a so-called virtual asset, while other types of assets are real assets. But regardless of its type, the value of Bitcoin is market-oriented and objective. Therefore, based on such value, it is possible to issue stable coins.

3.1. Market value of Bitcoin itself

Since its inception in early 2009, the total market price of Bitcoin has risen from zero to nearly $200 billion. The highest period in history was about $400 billion. A portion of this total market value is used for collateral, and then a stable currency is issued on these collaterals, and a certain amount of stable currency can be issued.

3.2. Fairness of bitcoin spot prices

Bitcoin is not supported by any credit agency, and its value is determined entirely through market transactions. Although there are many trading markets around the world that trade in bitcoin, the fairness of the market cannot be guaranteed because most of these trading markets are under non-regulatory. In fact, studies have shown that the market price of Bitcoin is indeed manipulated. It is precisely because the fairness of this market price is not guaranteed, so the US SEC has delayed approval of the listing of bitcoin ETFs. If the stable currency is issued based on Bitcoin, the fairness of the price of Bitcoin itself must be guaranteed. The measure that can be used for this is to use some fair price indices on the market. For example, CME's bitcoin futures trading price is based on a comprehensive index of the UK Facility Group, which is based on several bitcoin transactions in different regions. The price of the company is integrated. Bakkt plans to launch a bitcoin one-day futures based on physical delivery. This product is very beneficial to provide the real market price of Bitcoin. The stable currency issuer can provide the real market price of Bitcoin in real time based on these prices.

3.3. Adequate liquidity support

The basis of this coinage mode is sufficient liquidity. When the value of the mortgaged bitcoin falls to the closing point, the stable currency issuer needs to have sufficient market liquidity to sell the pledged assets. This requires stable currency issuers to work with the world's largest bitcoin exchange to be able to trade off the mortgaged bitcoin assets in a timely manner. This problem is actually a very big challenge. Because the amount of Bitcoin that it needs to process is a certain amount. It is a very strong professional job to sell such assets in a short period of time without causing a sharp drop in the price of the secondary market.

3.4. Technical structure of the coinage process

One of the main reasons why there is no stable currency issued based on Bitcoin mortgages in the market is that it is not possible to generate stable coins in a distributed manner based on smart contracts. At Ethereum, it is possible to control the mortgage of the Ethereum, the production of the stable currency DAI, and the clearance of the collateral through smart contracts. But because the underlying blockchain of Bitcoin doesn't provide this kind of functionality, it's impossible to implement an automated coin-forming process in a completely technical way. So a new technology architecture is needed to implement such a coining process. This technical architecture will have two layers. The bottom layer is the bitcoin blockchain for bitcoin hosting. The upper layer is a blockchain that supports smart contracts. The underlying bitcoin needs to be mapped to the upper layer. At the top level, smart contracts are also used to support the entire coining process.

3.5. Trusted Bitcoin Hosting

There are two ways to host Bitcoin mortgaged. One is a fully centralized hosting model, and the other is a chain-based hosting model based on technology solutions.

The benefit of a centralized, hosted approach is that cold storage can be taken. The managed bitcoin is stored in a physically isolated manner. This greatly reduces the chances of technical hackers stealing bitcoin. But this approach also has its obvious weaknesses. First, it needs an organization that holds a compliant license plate to provide this service. Such an organization does not easily provide hosting services to all users on a global scale. Because it is a centralized hosting, there must be artificial uncertainty. Bitcoin collateralized by the user may not be free to use for other reasons. Finally, because it is a centralized way of hosting, this way is less responsive to the market, and can not deal with the mortgaged bitcoin in time as the market changes and the needs of customers.

The advantage of using a technical solution to host Bitcoin is that the human factor is greatly reduced. The range of users who can serve this way is much broader. Users are free to use their own bitcoin in accordance with predetermined rules. And this approach is more effective in responding to market changes and customer needs in a timely manner.

3.6. Supporting the organization of coins

Since the birth of Bitcoin, the development of encrypted digital assets has basically been developed along three major lines, digital financial products, blockchains that support the flow of digital financial products, and the application of consensus mechanisms in technology and social organization. In terms of organizational form, the company's first application is The DAO of Ethereum. It is the first attempt to use the mechanism of community voting to jointly determine the technological development direction of Ethereum. The MakerDao project is also trying to apply the same voting decision mechanism. The Libra Association is also developing in this area. Although it still operates by means of human decision-making voting, in order to ensure a stronger foundation for organizational development, it is believed that the Libra Association will fix more business rules through smart contracts and automatically execute them. The trust of many institutions and individuals is involved in building this ecology. In the subsequent stable currency project, this kind of consensus mechanism based on technology guarantees will be a mainstream organizational form among alliance-type companies.

In such a coinage process, it is very likely to adopt the SuperNode Alliance approach. Participating nodes participate in the development of relevant coinage policies and provide minimal human participation. It should have the following similar attributes: “The institution that is based on the mortgage ST asset issuing must be a DAO institution with a common decision mechanism consisting of a distributed node. This agency performs functions similar to the central bank. This DAO is shared by some super nodes. These super nodes should be distributed to the major economic regions of the world. The decision of DAO is decided by these super nodes. In this respect, the governance model of DPOS in the public chain can be used for reference." ( Bitcoin, everyone's coin The forerunner of the pattern ).

Fourth, the core factors of this coinage mode

4.1. Hosting mechanism

In this business, the security of assets is the primary issue. Whether it's a centralized hosting approach or a combination of business and technology solutions, you need to ensure the security and free use of your customers' assets.

4.2. Liquidity

The liquidity of digital asset trading is the foundation of this business. Sufficient liquidity is both a fair guarantee for the pricing of various digital assets and digital currencies, and a guarantee for the security of customer mortgage assets.

4.3. Supporting the issuance of stable currency blockchain

In this infrastructure, the second layer of blockchain needs to support the storage and circulation of stable coins. The performance of this blockchain can be simple or more complex. If you only support a single financial product currency, such a blockchain can get better performance by giving up some features. But if this is a Turing-complete blockchain that supports smart contracts, then such a blockchain will be more scalable in the future, but it will need to accept some performance shortcomings. This is a technically important choice for organizations that issue this stable currency.

4.4. Trustworthiness of the operating organization

Since this coinage model cannot be completely technical, it is necessary to have a social organization to provide minimal human management. The fairness and trustworthiness of such an organization is the key to this organization. The organizational model of the Libra Association can be used in this regard. Because of the fairness and trustworthiness of the Libra Association, it can attract leading and direct competitors from relevant industries to join the association. Without the fairness and trustworthiness of such an organization, this coinage business cannot attract more members, so the business cannot grow bigger.

Fifth, the application scenario of the new stable currency


The application scenarios of stable coins in the future will be diversified. A digital stable currency that performs a single function will appear in different application scenarios. In the current field of digital assets, the most obvious area of ​​growth is global digital asset trading. However, due to the compliance of local banks, it is inconvenient for users worldwide to trade in French currency. This also led to the birth of the first digital stable currency, Tether. Among the stable currency products produced after Tether, their most important application scenario is still digital asset trading. At this stage, the application of digital stable currency to a retail payment business in the popular area of ​​the French currency is completely unnecessary, as there is no such demand in the market. The best application scenario for stable coins based on bitcoin should still be digital asset trading.

6. Impact on mainstream financial markets


The market value of bitcoin that can be used for coinage in this model is about $4 billion, based on the size of Bitcoin's market value of $200 billion and the MakerDAO mortgage casting stable currency with reference to 2% of the current total of Ethereum. If you use the same discount rate as MakerDAO, the value of the stable currency that can be minted in this way is about $2.6 billion ($4 billion*67%=$2.6 billion). This volume is negligible relative to the market for mainstream currencies. In addition, since such stable coins will definitely be mainly used in the field of digital asset trading, there are also different direct links between the real economy in the field of application. The impact of stable coins minted in this way on existing financial and economic systems is negligible.

Seven, the explorer in the industry


The issuance of stable currency based on bitcoin is feasible in terms of value base, market liquidity and production mechanism. I believe that many teams in the market are studying the feasibility of doing this kind of business. In this coinage business, in addition to some of the factors discussed in this article, other key factors include whether you can get enough bitcoin for mortgages, and whether you can build an organization like the Libra Association to run this stable currency. . Such a coinage project is obviously not a team can do, and should not be carried out by a family. In contrast, a company like Facebook can't rely on itself to develop a stable currency business, let alone other companies or teams.

One attempt in this area in the industry today is PayPal Finance. PayPal Financial is an integrated financial services provider that provides digital assets. It is now collaborating with some of the leading institutions in the cryptocurrency industry to launch an alliance based on pledged bitcoin issued stable currency. The members of the alliance jointly decide the coinage mechanism of this stable currency and share the risks, and adjust the interest rate and the pledge rate to cope with market changes. If there are ten institutions involved in the alliance, each pledges 2,000 bitcoins, then the market value of the assets in the pledged bitcoin pool is about $200 million. This has the basis for a stable currency issue. If the same discount rate is used for MakerDAO, then such a bitcoin can generate a stable currency worth about $140 million. However, if the mechanism of the project is properly designed, it will attract more institutions and users to participate in the alliance and pledge more bitcoins, so the number of stable coins that can be issued will naturally increase.

In short, the stable currency is essentially a product, so its circulation mechanism in the market is the same as other products. At present, there are already stable coins produced in various ways in the market. However, because the market demand for stable coins is gradually increasing, there are room for development of existing stable currency products and future stable currency products in the market. But which stable currency products can develop in the long run depends not only on their production mechanism, but also on application scenarios and marketing. For most stable currency products, they do not have resources like Libra, so their market positioning needs to be particularly clear and needs to be able to establish their own unique advantages in a segment. You must not define yourself as a universal product, competing with other stable and legal currencies in all aspects. If it is fully rolled out, it will be lost to products like Libra.

Author: Valley Yancey