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Money and the State: Shifting the balance with Stablecoins?

Money and the state has evolved dramatically over time. In the digital era, rising prominence of cryptocurrencies looks to upend the balance. With problems of speculation and price volatility, stablecoins seek a reliable means of payment, whilst retaining the promise of blockchain.

Khalil Gilders

Khalil Gilders

— 9 min read
Money and the State: Shifting the balance with Stablecoins?
Photo by DrawKit Illustrations / Unsplash

The relationship between money and the state has evolved dramatically over time. From barter to demand notes, and eventually fiat currencies, this relationship is one of increasing state dominance over the supply and regulation of money. In our new digital era, the rising prominence of cryptocurrencies (and blockchain-utilising adjacencies) looks to upend the balance of this relationship once again. In particular, with the problems of speculation and price volatility of traditional cryptocurrencies, so-called ‘stablecoins’ have sought to provide a stable and reliable means of payment, whilst retaining the core, decentralised promise of blockchain technology.

Whilst many groups proclaimed an immanent financial revolution (with rising coins such as Meta’s Diem), the question remains as to how revolutionary these means of payment really are. That is, will stablecoins really become the primary means of payment, and – more importantly – do they really achieve the financial decentralisation they promise?

Unfortunately, it seems inevitable that the size and scope of regulatory financial institutions of the EU, US, and UK will render the promise of global stablecoin adoption incredibly limited. However, even if stablecoins were adopted as a primary payment means, the ideology of stablecoins – as is the same for many cryptocurrencies – would lead to the same centralisation of control it promised to end.

1.     The relationship between Money and the State

The origins of both money and the state are subject to an intense academic debate. However, for simplicity, I take the ‘functionalist’ theory of money (taken from Adam Smith), wherein money existed as a means of exchange which improved upon the previous barter model, due to its properties of easy transportation, storing, and its ability to overcome the ‘double need of wants’ (where both parties need to want each other’s goods to engage in barter).

As civilisations progressed, barter was largely phased out, in place of a standardised currency. Initially, this currency was a made of valuable metals, such as silver and gold – goods which had direct value to its users. The emergence of states allowed this model to expand, as states became the enforcers of its value. For instance, the issuance of demand notes such as ‘greenbacks’ in 19th century USA, which were a promise to pay the bearer an amount equal to the notes held.

However, the role of the state as merely a guarantor of the value of promises drastically changed in 1971 when Nixon removed the gold standard backing from the US dollar. Until this point, notes were based partially on the trust individuals had to the government, but importantly in the gold reserves which the state held to ensure its value. Removing this assurance shifted the balance hugely towards the state, as the value of new fiat money was based solely on trust in the government. Furthermore, the Federal Reserve was granted far greater powers over the supply and regulation of money, to target inflation and employment. In this way, individuals ceded the power to collectively control and regulate money, to centralised government institutions.

Whilst fears about the control of such a vital commodity as money was held by some, it was generally accepted by the population as time passed. However, these fears came to fruition in 2008, when risky capital investments into the mortgage market caused a global financial crisis. Many saw the bailing out of the very institutions which had caused the collapse, by the state, as evidence of moral hazard of allowing a few institutions almost absolute control over the money used. Many also pointed out that the banks’ – who controlled the vast majority of the population’s savings – use of a ‘fractional reserve’ system (whereby only a fraction of the money held in accounts is held in cash on the balance sheet) meant that people’s money was never completely safe from a run, particularly not if they acted financially irresponsibly.

Growing numbers of people – fearing for their savings, and mistrusting governments and banks to ensure the stability of money – attempted to circumvent fiat money through a variety of means. With the explosion of global protests, such as the 2009 Occupy movement, Bitcoin – the first cryptocurrency – was released as just such an alternative in the same year. Such a currency would be free from the issues of trust, it argued, as well as monitoring – as Goede (2012) explains, in the state’s increasing use (post-9/11) of security monitoring in the mainstream financial system.

Thus, the history of the relationship between money and the state can be seen as one of the rising dominance and control of the state and central financial institutions. Whilst the people originally controlled what to accept as money, and determined the value of goods, this was eventually ceded to the state itself. The rise of stablecoins, however, seeks to reverse this balance.

2.     The Technology and Ideology of Stablecoins

Stablecoins themselves are not a new invention of the cryptocurrencies community. As far back as 2014 – just 5 years after the invention of Bitcoin – the first stablecoins of BitUSD and NuBits were released. To assess the claims of a ‘revolution’ in the money-state relationship, we need to look first at the direct technological features of stablecoins, and then at the ideology that underline them.

a.     The Technology of Stablecoins

The purpose of stablecoins was in response to the high price volatility of popular currencies such as Bitcoin; the rapid changes in price meant Bitcoin was less suitable for common uses, such as paying wages, buying groceries, or accumulating savings (despite the ideal of cryptocurrencies to become the primary means of exchange between people). So, stablecoins were invented to plug the gap and provide a blockchain-based currency which excluded middlemen of the banks and state and maintain a constant and reliable per-coin value over time.

Technically speaking, stablecoins are a particular type of cryptocurrency whose value is pegged (or tied) to that of another currency, commodity, or financial instrument. For example, a stablecoin which is pegged to the US dollar will have an exchange such that 1 coin can be exchanged for exactly 1 USD – a promise which is meant to be kept over time.

Stablecoins ensure this price stability through a variety of means. Stablecoins such as Tether have used fiat collateralisation to ensure the stability of their prices. This is where the price of each coin is backed by 1 unit of the pegged fiat currency, physically held in reserve by the platform which owns the stablecoin. In Tether’s case, this meant that the total value of their USDT coins in use were backed by a reserve of the same size on dollars – such that it would be impossible to perform a ‘run’ on Tether. It is important to note, however, that fiat collateralisation is often very costly, and that in Tether’s case, the price dropped below the promised dollar mark, due to embezzlement from company heads.

An alternative system is of algorithmic pegging, where smart contracts in the code maintain (in theory) the price of each coin. This is achieved via an automatic altering of the supply of the stablecoin, to adjust the price. However, this means that the prices tend to be more volatile than with fiat collateralisation, since changes in supply of a currency do not lead to a 1:1 change in the demand price.

In this way, problems with the promise of stablecoin appear when looking at the digital technology alone. Algorithmic pegging is a weak alternative to fiat collateralisation, explaining its narrow market adoption. But a wider use of fiat-collateralised stablecoins presents a principal-agent problem – that the full backing of a coin is hard to observe, and thus easy to embezzle from those few that control it. Aside from affecting the price stability, this moral hazard also violates the core purpose of cryptocurrencies: to remove middlemen and state institutions from control of supply and transaction of money. In fact, the centralisation of this power to a few private platforms implies a lower accountability and safety than traditional fiat currencies.

b.     The Ideology of Stablecoins

However, the digital technology of stablecoin only gives us half of the story of how stablecoins seek to upend the money-state relationship. To appreciate the bigger picture, we need to understand how the ideology behind them has shaped and changed their use and adoption.

Stablecoins share much of the same political ideology behind the wider cryptocurrency community (and in fact, would see stablecoin as the ‘true’ way to apply the ideology’s aims). These groups include the P2P (peer-to-peer) lending movement (e.g., Prosper, Upstart, and StreetShares), which attempts to connect borrowers directly to lenders, and so eliminate banks from the equation. More radically, Irving Fisher’s notion of ‘100% money’, which sought to eliminate the right of banks to produce money, has been echoed in the UK Positive Money and Icelandic Betra Peningakerfi campaigns. Each of these wishes to decentralise the production and control of money and remove the institutions of the state and banks from the equation.

However, it seems questionable the extent to which the result of these ideologies can in fact create a system that is anything but the structure of the very one they oppose. For example, Dodd (2017) convincingly argues that many traditional cryptocurrencies – such as Bitcoin – can be ‘mined’, allowing for the accumulation of currency by wealthy groups, producing ‘whales’ which have significant sway over its market value, and thus control over the currency. Whilst most stablecoins can’t be mined, they are subject to the issue of accumulation, as well as the additional problem of centralisation. That is, that most stablecoins exist on a handful of centralised platforms, such as Tether, USD Coin, and (would-have) Diem. These give the privately-owned platforms the very same level of concentrated production and control which proponents sought to eliminate. New middlemen appear, such as reserve managers (often commercial banks), wallets (which can block transactions), and network administrators (who can change the rules of the network). All that holds together the maintained support for these stablecoins is the “socially necessary fiction” that the platforms will not intervene to alter the price. Ironically, the same fiction existed about the ‘too big to fail’ banks, prior to 2008 (and a fiction that has proved itself again with the relative collapse of popular stablecoins Luna, Tether, and TerraUSD).

To make matters worse, these companies still exist within the sphere of regulation, and thus, will be subject to security and transaction regulation from state institutions – despite their utilisation of the blockchain. The fact that the state is unwilling to take the challenge to the balance of power in the money-state relationship should be relatively unsurprising; given both the history of the money-state relationship, and the current influence of banking and state institutions over the global financial system. For example, the EU – the largest single market in the world – has already released a series of regulatory frameworks to assert better control over stablecoins. This includes the 2018 Markets in Financial Instruments Directive (MiFiD) II, and the planned Markets in Crypto-Assets (MiCA) regulation. Both bring stablecoin cryptocurrencies under the purview of EU regulatory authorities, giving state institutions far more control over the currencies than the initial promises of decentralisation suggested.

As such, it becomes increasingly difficult to see how the adoption of stablecoins – both in their technological and ideological realities – will upend the money-state relationship, and instead, is not simply a changing of hands to private companies.

Conclusion

In conclusion, then, we have seen how the history of the relationship between the state and money has been one of increasing dominance of the former over the latter, and the ceding of power from the people, into the hands of increasingly centralised institutions. Whilst stablecoins have attempted to generate a convincing challenge to this power imbalance, it has failed to sway many in terms of the technological limitations for its adoption, as well as the arguably identical power imbalance that it creates between institutions which control the currency, and people who use it.

With increased pressure for regulatory control over stablecoins, it is practically impossible to see how the modern-day dynamic of money and states can ever be uprooted, in place of a decentralised, whilst truly stable, currency.

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