IOU price vs trust - a look at Tether

Fiat-denominated IOUs have a long history in the crypto space. Ripple launched in 2012 with its host of fiat gateways. BitUSD and TetherUS began circulating in 2014. PayCoin launched and died in 2015. It seems that recently Tether has gotten itself into some banking problems and its price started to reflect that. While the ordeal is not great for the company or anyone holding the tokens, it's still an important lesson to be learned in the crypto space - a dollar is not a dollar is not a dollar.

Related articles:

• The rise of fiat-denominated cryptos
• BitUSD vs USD IOUs
• Full Proof of Solvency - pondering Tether

Tether

Tether is a company issuing fiat IOUs on the Omni network. At the moment they offer USD and EUR IOUs and claim to be 100% backed by their assets with a proof of solvency. However, their terms of service don't inspire confidence:

"

There is no contractual right or other right or legal claim against us to redeem or exchange your Tethers for money. We do not guarantee any right of redemption or exchange of Tethers by us for money. There is no guarantee against losses when you buy, trade, sell, or redeem Tethers.

"

That being said, for a long time their USD price remained rigid in comparison to things like bitUSD. That is understandable - exchanges would accept it at par rather than trading it like any other asset.

Banking problems

A month ago, Bitfinex and Tether ran into some banking problems with Wells Fargo. The latter was acting as a correspondent bank and decided to block wire transfers between the crypto companies and their customers. Those wishing to cash their tethers out need to go through Kraken, which decided to take a ~7% premium for the service due to the market problems.

There are also some alleged shenanigans going around the actual use of tethers by exchanges and the BFX tokens (related article), but that's not directly relevant to our discussion at hand.

Dollar-dollar market

What this scenario shows is that there is that every currency needs a real market.

A long time ago, before central banks became prominent, each bank used to issue their own banknotes and the value of said banknotes would fluctuate based on the trust in the bank and so on. While that was a horribly inefficient system for the brick and mortar world of retail, wasting countless hours on currency conversions, individual counterfeit measures and so on, it could work really well in the digital space.

A dollar from one bank or exchange is not worth the same as a dollar from another. A faster, more efficient exchange would have their tokens valued more favourably than a slow, clunky one. Eventually, the market would settle at some price that would indicate the level of confidence or quality of the exchange and that metric would be clear for every customer to see. We had that with the final days of MtGox.

At the current time, the only place we can see a clear market like that is Ripple - you can actually trade USD IOUs from two different gateways for one another (at the time of writing, the exchange rate between Gatehub and Bitstamp USDs is about 1.11). While each gateway accepts their own tokens at par and allows you to withdraw the USD to your bank account, the price is driven by market makers that decide what premium to charge. If someone else finds a way to close that gap, they have a chance to make some money and bring the market into a more realistic exchange rate. In the end, the market decides what each IOU is worth, not some exchange.

Conclusions

While the current Wells Fargo problem is an important issue for Tether and Bitfinex, it is an important example for why we need a liquid market for all tokens, even those denominated in fiat. That and why correspondent banking is a thing that needs to be replaced by cryptocurrency networks.

A dollar is not a dollar is not a dollar.

Global Reserve Currency - Special Drawing Rights vs Bitcoin

Earlier this month, the G20 summit was held in China. One of the more interesting topics discussed, was the addition of Chinese yuan to the SDR - Special Drawing Rights. The topic of SDRs is rather important, but it doesn't seem to be discussed all that widely in the crypto community, so I figured I would cover it today.

Special Drawing Rights

Special Drawing Rights, or SDRs, are supplementary foreign exchange reserve assets defined and maintained by the International Monetary Fund (IMF). They were created in 1969. SDRs are allocated to countries by the IMF, and private parties do not hold or use them. The value of SDRs is based on a weighted basket of currencies (currently, 41% USD, 31% EUR, 11% CNY, 8% JPY and 8% GBP, worth about 1.39USD/SDR).

Special Drawing Rights are posed to replace the dollar as the world reserve currency. They serve well as a unit of account (due to lower volatility), can work well in international law (to have an objective measurement of value across multiple countries), and some countries even started pegging their currency to the SDR (due to increased transparency).

While the IMF and SDRs might not be an entirely ideal solution to creating a new, global currency (with US having a veto power and failing to ratify some reforms for example), it might be a step in the right direction.

Where SDRs fall short

While the Special Drawing Rights are an interesting idea, they fall short in a one key area - they appear to be inaccessible for anyone short of a government. This can limit how useful the currency can be for say, creating international settlement, or using it as a measurement of value for corporations or even individuals.

If SDRs were a publicly available and tradable currency, it would be really interesting to see it used for pricing items, wages, etc. to counter currency wars. If your wage is pegged at 3000USD/month, whether USD goes up or down, you're paid the same amount of dollars. But if your wage was instead set at 3000SDR/month, you would receive the same value each month, no matter if it meant you got 2500USD when the dollar is strong, or 3500USD when it was weak. This could give anyone a protection from the government's meddling.

Crypto SDRs

Creating a currency based on a basket of other currencies is also not an entirely new idea in the crypto space either. Paul Grignon (author of Money as Debt) has described his take on the idea as Digital Coin back in 2009. A part of the system, called Perpetual Coin, would initially be issued based on a value of a basket of currencies. Unfortunately, the project never left the conceptual phase, and the website is down now, so it is unlikely we will see it ever implemented...

Other than that, there doesn't appear to be an SDR-pegged cryptocurrency out there. This might perhaps be due to the fact that we already have a better alternative to the Special Drawing Rights - Bitcoin. What it lacks in stable value at times, it more than makes up in terms of being all-inclusive and, at least so far, immune from government influence.

It wouldn't be hard, however, to create an SDR-Coin - it could function like Tether, or perhaps more accurately, like BitUSD since you couldn't exactly withdraw the coin. The main problem for a centralised issuer would be keeping the valuation of the currency stable, especially in periods where the basket of currencies is adjusted. Other than that, once the currency itself is created (and I would almost bet we would see someone make the currency after the article is published - 700+ cryptos is not enough after all), it would be interesting to see it start being used internationally. Perhaps we would finally see what is the real demand for SDRs for corporations and real people, rather than just governments. With any luck, this might just hurry the demise of the USD or "petrodollar" hegemony.

Conclusions

Special Drawing Rights are an interesting take on creating a new global reserve currency. While it is currently only accessible to governments, it could be very useful for corporations and end-users. For the time being, Bitcoin is the most accessible alternative for the rest of us.

Inert versus volatile currencies - pondering an attack on BitUSD

When thinking about a currency on a simple exchange as a fairly inert object. You can throw money at the market, swing it up or down, but without other actors taking an action by themselves, the market will remain the way you left it. You might cause a panic, or your order might be eaten up by traders with strong confidence in the current price.

Now, consider a derivatives market like BitUSD. While you may have the same market as in a simple exchange, there will also be a lot of collateral in that market waiting to be called upon if one would need to make a margin call. Depending on how the market is structured and how much money is potentially available for margin calls, someone wishing to exploit the market could have a powerful force multiplier waiting to be unleashed. You could call such currencies "volatile" - not in a sense of finances where the price fluctuates a lot, but more of a chemical sense - that there is a latent force in those currencies that could be unleashed for one's benefit.

BitUSD - quick recap

BitUSD is a "market pegged asset" on the BitShares Crypto 2.0 platform. It is created as a derivative of the native bitshares currency. As such, it is a "counterparty-less fiat-denominated crypto". Its value is kept at around 1 USD by an open, decentralized market. BitUSDs are created as a derivative with a collateral of three times the current BitUSD value in bitshares.

The snowball effect

Under normal conditions, the futures market should be stable. You might see some spikes every now and then and perhaps some margin calls being made on an infrequent basis, but the market should track the proper values.

However, it is also possible that a market might have a tipping point - a price at which a snowball effect might take place. Lets say the current market is like this:

• The current price is 100 BTS per BitUSD
• It takes:
• 10k BTS to move the price from 100 to 200 BTS per BitUSD
• 10k BTS to move the price from 200 to 300 BTS per BitUSD
• 10k BTS to move the price from 300 to 400 BTS per BitUSD
• When the price:
• Reaches 200, 5k BTS will be used on margin calls
• Reaches 300, 15k BTS will be used on margin calls
• Reaches 400, 25k BTC will be used on margin calls

If we throw 5k BTS into the market, not much happens - we moved the price a bit. If we throw 10k BTS, we force the market to spend another 5k BTS. We moved the price by 100, and the margin calls moved it further, multiplying the strength of our move by 1.5.

If we throw 15k BTS into the market, we first force the 5k BTS to execute margin calls, adding to a total of 20k BTS. This is enough to trigger the next wave of margin calls - another 15k BTS is pushed through the market on margin calls. This in turn is more than enough to trigger a third wave of margin calls adding another 25k BTS into the market.

This way, our initial push of 15k BTS has forced the market to execute additional 45k of orders (60k in total), thus multiplying the strength of our move by a factor of 4.

A similar scenario was described by James Rickards in his book Currency Wars.

In a centralized world, you would expect the exchange facilitating such trades to trigger a trading curb, perhaps even reverse some trades if they suspect malicious intent. However, a decentralized, anonymous marketplace might have a problem trying to unwind what has happened.

How to benefit from such an attack?

There are several ways one can benefit from executing such an attack. Of course, some preparation is needed.

First of all, one could go to a separate exchange or a prediction market and bet on the price of BTS going down. If the market is well established and has enough participants with open positions, it might be easier or harder to earn some money this way.

Secondly, one could position the open trades on the BitShares market itself in such a way as to benefit the most from the margin calls. In our example, we could slowly build up the price of BTS in preparation for the attack, while also amassing a good portion of BitUSD and creating open sales at over 400 BTS per BitUSD. This way when the final wave of margin calls is executed, we will be able to sell our BitUSD for 4 times as many BTS as they were initially exchangeable for. The amount of BTS amassed could be then used to manipulate the delegate market.

Lastly, there is always a room for competitors to employ some malicious tactics against BitShares. At the current market cap of 12M USD, competing 2.0 platforms like for example Ripple might dwarf the market twice over with their Series A financing to strengthen their own position in the market. While I don't believe any of the Crypto 2.0 platforms would even plan to employ such tactics in the near future, there is nothing you can rule out.

Conclusions

While BitUSD is an innovative creation with a big potential, I would still like to see some practical analysis of how robust the market is. Does it have a tipping point, and if so - what is it? Since all transactions are public, the attackers wouldn't have a problem figuring it out.

In the end, this discussion brings to mind a field of mousetraps - they can be "diffused" or triggered safely in low concentrations, but if you have too many clustered in one place...