STABLE Act ushers in a new crypto political age

Plus AMM Math Twitter battles

Okay, here’s my hot take: the STABLE Act Bill will not pass.

While much of crypto twitter’s ire was directed at the academic behind the bill, Rohan Grey, the politics can better be understood through the bill’s sponsor, U.S. Representative Rashida Tlaib, an unabashedly liberal congresswoman from Michigan and one of two members of the Democratic Socialists of America (DSA) in Congress (along with AOC).

The politics of the STABLE Act could not be clearer. Checking the power of large financial institutions is already a politically popular position, but Tlaib is adding one more bogeyman: Big Tech, or more specifically Facebook, who’s Libra/Diem/Novi/whatever seems to be the target of this bill. From the Congresswoman’s STABLE Act announcement:

 “Facebook has attempted  to take advantage of the financial exclusion and gap in the market—just one of the actors that have pursued issuing stablecoins by pegging them to a basket of major conventional currencies. JP Morgan, Apple, and Paypal/Venmo have also considered issue their own stablecoin variants that also have the potential to take advantage of unbanked and underbanked communities.

This is a smart move politically. There is bipartisan suspicion of the tech giants; the left fears their monopoly power and the right fears their media censorship capability. Still, Congress is having trouble agreeing on a stimulus package amidst a raging pandemic, so I can’t imagine them finding common ground on stablecoin legislation.

Instead, the real takeaway is that the long anticipated (or feared) political and legislative battle for crypto has finally arrived. Yes, the SEC and other U.S. government agencies have regulated some aspects of blockchain and cryptocurrencies, but this bill is the first to address the potential systemic risks to the U.S. banking system from crypto currencies.

This is a huge step. The government is no longer just going after criminals and scammers that are using crypto. Rather, this legislation recognizes the success and rapid rise of blockchains – specifically stablecoins traded on Ethereum, and aims to regulate them because they represent a systemic risk for the US financial system and economy (says the bill’s supporters).

The takes on Twitter are faster and hotter than ever, but this seems to capture it the best:

Regulation scope depends on enforcement capability

The nightmare scenario of decentralization enthusiasts is criminalizing the act of running an Ethereum node. If there is not a central issuer for a stablecoin (like USDC & Circle/Coinbase) that is traded on Ethereum, then any Ethereum node operator would be liable. These fears are misplaced, says one of the bill’s authors Rohan Grey, “we selectively enforce laws all the time when we think *everyone* shouldn't do the illegal thing.”

So, don’t expect a SWAT team coming for your raspberry Pi Ethereum node – but they could!

Still, as the STABLE Twitter debate showed and Circle’s Jeremy Allaire conceded: there will be some regulation of stablecoins. The question is how? Enforcement can come at any ‘chokepoint’, whether that be a bank account to close or a legal entity to sue.

Tether, USDC and most existing stablecoins are all backed (or supposed to be) 1:1 by a US dollar in a bank. This means that they are effectively regulated now – just with little to no restrictions. In a world of closer regulator scrutiny, there is not much they can do to resist, which is why you see Jeremy Allaire doing some pretty effective politicking to appeal to the incoming Biden administration for favorable regulation.

Veil of Decentralization

The elephant in the room is MakerDAO’s Dai stablecoin, which dubs itself as a “decentralized currency” and now has over $1bn in circulation.

Up until March of this year, it had a reasonable claim to be backed by “decentralized collateral” (ETH) but with the events of Black Thursday and the subsequent addition of USDC as acceptable collateral. Dai’s collateral breakdown is now:

via Daistats.com

Less than 45% of the assets backing Dai are native to the Ethereum blockchain, and the majority of Dai collateral is ultimately held by regulated custodians. Dai interest rates, collateral onboarding and changes to the Maker protocol voted on-chain and MakerDAO has ambitious plans to decentralize, but they are in no position to resist U.S. regulators, not even considering the Maker foundation or their highly visible investors.

Synthetix’s sUSD has no custodied collateral backing it, but it’s entirely backed by the SNX token and there is a pretty central team working on it (for now). Most of the existing DeFi projects suffer from what Angela Walch dubbed, the “veil of decentralization”.

Can DeFi scale without USD from banks?

The thing is, Ethereum really is decentralized.

And it’s not just me or crypto fan boys saying that. The SEC said so in a 2018 speech on whether or not Ether is a security, arguing that it has reached “sufficient decentralization”. There’s an interesting argument that PoW chains are more susceptible to legal enforcement because of miner centralization (hard to hide a large mining pool), but Ethereum’s recent launch of its PoS chain should make the network just as decentralized as the asset.

But is ETH enough? Can stablecoins scale using only decentralized collateral not reliant on the US banking system?

Maker faced peg stability problems in March and ran into scalability problems over the DeFi summer when there wasn’t enough ETH collateral to meet soaring Dai demand for farming.

Scaling censorship-resistant stablecoins and synthetic assets in general will require A LOT of on-chain collateral (censorship-resistant, of course).

Algorithmic stablecoins to the rescue?

Non-collateralized stablecoins can scale and be censorship-resistant but they are still in development stage. Andrew Kang with an A+ thread on these:

In addition to these, there’s Rai, a “low volatility collateral for DeFi”, that promises to be decentralized and censorship-resistant.

What’s next?

I think stablecoins will be shockingly easy to regulate and rely more on institution and consumer choice than heavy-handed enforcement. Yield Protocol founder Allan Niemerg with this astute observation:

I think the analogy mostly holds, but I don’t expect a new system to be built from the ground up, as the streaming services did. Instead, it will be as if Spotify and Netflix were built on top of Bittorrent, meaning that a regulated, digital USD will in some, shape or form, run on Ethereum.

Nothing in this bill hinders Ethereum’s ability to serve as a global settlement layer for the world, if anything, it strengthens it by stymying Facebook and other well-heeled competitors.

The question that remains unanswered is the currency debate. Bitcoin and Ethereum’s monetary systems are completely independent from the US system and could actually power a new economy, but that is a much larger (political) challenge.

Apparently there’s now a debate hosted by The Block with Jeremy Allaire and Rohan Grey Tuesday 10am ET. Other related things:

Tweet of the Week: AMM Math battles

A Twitter thread in response to Uniswap’s Financial Alchemy post from Paradigm about how AMMs may not have to worry about impermanent loss, because in the long-run the 50/50 rebalancing optimizes a porfolio’s wealth. As Dave White and Martin Tassy say in their post, “If the volatility of an asset is high enough relative to its average rate of return, LPs on Uniswap will do better than HODLers over time, even when the only incoming trades are arbs. This is due to a phenomenon known as volatility harvesting.” Rebalancing is a free gift of idle liquidity. SBF disagrees with the math (and also runs the largest market maker). Hopefully there will be a math battle podcast soon.

Chart of the Week: DeFi returns since the bottom

It’s hard to believe we saw a whole market cycle in the three months after the DeFi summer. Times were dark in October but recovered rather quickly, as the chart above shows. Sushi, YFI and Aave were the big winners of the rebound. Aave just unveiled v2 of its protocol, while Yearn has been partnering with every DeFi lego it can. The latest of which is Sushi, the top-performing token as it rolls out new feature after new feature.

Odds and Ends

  • Gitcoin Grants Round 8 kicks off Link

  • 1inch raises $12m, led by Pantera Link

  • Maker moves closer to adding Uniswap LP tokens as collateral Link

  • Rumored new rule from Treasury would require exchanges to KYC self-hosted wallets for withdrawals & deposits Link

  • AMA with Equal Parenthesis from the Empty Set Dollar founding team Link

  • Opyn v2 Introduction + Bug Bounty Link

Thoughts and Prognostications

That’s it! Feedback appreciated. Just hit reply. Written in Nashville, where it’s cold but the Christmas lights are nice.

Dose of DeFi is written by Chris Powers. Opinions expressed are my own. I spend most of my time contributing to DXdao*. All content is for informational purposes and is not intended as investment advice.