While the closures this year of crypto-friendly banks Silvergate, Signature and Silicon Valley Bank have been setbacks for both the financial services sector and the crypto industry, pain and strife begets opportunity.
Just as the collapse of FTX highlighted the value of self-custody — not to mention prudence in the face of messianic mountebanks such as Sam Bankman-Fried — this year’s bank closures prove one thing above all else: Stablecoins fully backed by reserves held at regulated financial institutions are the future of finance.
It’s time for stablecoins to act
Stablecoins represent an upgraded alternative for the movement of money.
I’m a firm believer that ideal outcomes almost always exist somewhere in the middle between two extremes. The current financial system and DeFi are two such extremes — so for Web3 to really be the future of finance, we need to encourage solutions that fall in the middle.
Fully-backed stablecoins provide a strong middleground alternative to a fractional reserve system that seems to be on shaky ground, providing a way forward to further improve our financial system.
On the DeFi side, we see a slew of totally unbacked stablecoins: One of them, terraUSD, relied on an algorithm-based arbitrage mechanism to maintain its dollar peg and collapsed last year, erasing $60 billion. The extreme end of the traditional finance spectrum, meanwhile, is the dreaded central bank digital currency (CBDC), and with it the prospect of increased surveillance, restrictions on spending and saving, automatic tax collection, and other fears.
If the recent banking crisis is going to spur on the exploration of a new financial system, then it’s important to find a happy medium: Fully-backed stablecoins are that medium.
But there are still hurdles to overcome before mainstream adoption is gained — like the current insufficiency of integrations to payment systems as well as the fact that many goods and services still cannot be purchased directly using stablecoins.
Stablecoins exist for a reason
During the previous financial crisis in 2008, there was no viable alternative to the traditional banking world.
Today, we have DeFi, which offers a parallel financial system built on decentralized technologies. And the recent banking failures have shown that this is a system that we need: after the collapse of three US banks in a row, consumers are actively looking for a safer alternative for their monetary needs.
Now, what that safer alternative is remains up for debate.
For those in the traditional markets, the answer to the problem of bank collapses is a CBDC.
For those in crypto, it’s clear that the answer needs to be a fully-backed stablecoin.
As mentioned, power brokers and regulators contend that CBDCs are the answer — digital versions of fiat currencies issued and regulated by a central bank. While they can offer various benefits, such as cheap transactions and increased financial inclusion, their implementation is a nightmarish prospect for some. Do you really want the same people who control the money supply to be able to increase its velocity? For these people to be in the position where they can activate a currency expiration policy that encourages you to use your capital or lose it?
And there’s another point to consider: CBDCs are unlikely to address the fundamental problems that lead to bank failures in the first place, such as poor management and risky lending practices. Banking collapses underline the failure of the fractional reserve system, which will likely be preserved in an era of CBDCs.
Fully-backed stablecoins, on the other hand, are pegged to the value of a fiat currency, typically the US dollar. And unlike projects such as terraUSD, they aren’t merely pegged to a value — they’re backed by fiat reserves.
This means that for every stablecoin issued, there is an equivalent amount of fiat currency held in reserve, ensuring stability and predictability to their value. Fully-backed stablecoins provide many of the benefits of CBDCs including fast, low-cost transactions and global accessibility, without the negatives. Importantly, they provide a way for users to hold value and transfer funds without depending on traditional banking systems.
But how might fully-backed stablecoins represent a solution to the problem of bank failures?
If people hold their funds in stablecoins, they can avoid the risk of losing their funds if the bank that holds the stablecoin collateral fails, as most stablecoin companies “spread” their deposits across multiple banks (and also back them up with US Treasurys.) In this sense, fully-backed stablecoins function as a safety net that complements traditional banking systems, reducing the systemic risks associated with the implosion of banks themselves.
Of course, regulators will argue that the best response to bank failures is one that necessitates their involvement. More regulatory oversight is always the answer, right? Or more insurance for bank deposits?
The problem is, these measures do not address the root cause of the problem.
In a fractional reserve system, banks are only required to keep a fraction of customer deposits in reserve, while the rest can be loaned out or invested, a process that perpetuates risk and often triggers a cycle of boom and bust. The more banks create money by lending and investing, the more risk of speculative bubbles emerging. And in the gravest case, a financial crisis when loans cannot be repaid.
Fully-backed stablecoins are not based on a fractional reserve system, and holders are not vulnerable to losing their deposits if a bank fails.
These stablecoins are neither subject to the risks associated with fractional reserve banking nor the risks of unbacked stablecoins — and this is why they are the real future of money.
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Source: https://blockworks.co/news/fully-backed-stablecoins-defi