All risk, no profit? The vague definition of stablecoin creates problems

Sometimes “stablecoins” and variants like “algorithmic stablecoins” act as historical names as they refer to projects that refer to themselves as stablecoins, such as: B. Basis Cash, Elastic Set Dollar, Frax and their clones.

The word “stablecoin” can be used as a logical description for “a cryptocurrency with low price volatility” and “stores of value or units of account” or “a new type of cryptocurrency whose value is often pegged”. to another asset … designed to cope with the inherent volatility in cryptocurrency prices, “or a currency that can” act as a medium for changing money and a way of storing money’s value, and whose value should remain relatively stable over longer time horizons . “

At the more metaphysical end of speculation, some have defined stable coin as “an asset traded in itself rather than an asset traded in supply and demand”. This contradicts everything we know about how markets work. “

All risk, no profit? The vague definition of stablecoin creates problems
All risk, no profit? The vague definition of stablecoin creates problems

From my point of view, circularity is the central issue. The alleged lack of Bitcoin (BTC) as money and a vague definition originally inspired a number of stablecoin projects. The design features of these projects have been reintroduced into the definition of stablecoin.

Haseeb Qureshi – a software developer, author, and famous altruist – defines a stable coin as simple pricing. howeverIt is not obvious that anything with a pad should be called stablecoin. Ampleforth has a “background” and was listed in the stablecoin category. The founding team regularly makes it clear that this is not the case.

So who is right?

Another example of what exactly is “stable” in a stablecoin: the background or its value? Wrapped Bitcoin (wBTC) is perfectly linked to Bitcoin – a wBTC is always a BTC. Is that a stablecoin?

Based on the original motives for creating stablecoins, BTC is not a stable medium of exchange, although Bitcoin is the canonical capital of “Storage of value“.

Once the problem is resolved – that no one knows how to define or recognize a stablecoin – the remainder of this paper describes a solution. It contains a well-defined description of value as a relational property, namely “value in relation to a unit of measurement”.

From this description I classify all digital assets comprehensively in two dimensions: the risk of loss or the probability of realizing an impairment; and the risk of profit or the probability of realizing an increase in value. We can then define stablecoins precisely and logically: assets where both the risk of loss and the risk of profit are zero.

This means

p (profit) = p (loss) = 0

I call this a risk-defined stablecoin.

It is clear that current algorithmic stablecoins have a risk of loss but no profit. As a result, not only are they not stable coins, but they are also terrible financial assets. Finally, I wonder if it makes sense to expand the concept of a risk-defined stable coin to a more general concept that focuses on expected value. A stable coin of expected value is one where the odds of winning and losing, weighted by the size of the loss and gain, are perfectly balanced and set to zero.

I conclude that the complexity and ergodicity of this concept precludes it from being a useful definition of stablecoin.

What is worth?

What “value” means is not entirely clear, as the ongoing debates about the “true” rate of inflation show. We can ask ourselves: Worth in terms of what?

That is, we choose to treat the value as a relational property between the measured object and the measured object. It’s like asking about the altitude: Do you want it in inches or centimeters? For our purposes, can we define a function that assigns a good to a set of numeric values ​​in a selected unit? I call it bravery.

For example, if the unit chosen is US dollars and the item is a bag of potato chips

USD value (potatoes) = $ 5.

We could have written too Height inches (table) = 35 inches.

Risk of loss, risk of profit

The value of an asset changes over time, so we can expand our value function to reflect the idea of ​​the “value of an asset in terms of a unit at any given point in time” by adding the time ( t) in that we measure the value:

UnitValue (Asset) = x

We can define risk as the probability that the value function will show an increase or decrease in value at some random point in time in the future.

In practice, this means that I would make a profit or loss if I converted the asset to the selected unit.

A stable coin defined by risk

Now we have enough to create a well-defined description of a stablecoin. A stablecoin is an asset where both the risk of loss and risk of profit are zero. That means: p (profit) = p (loss) = 0.

This means that if I sell the stablecoin asset in the future, I will not suffer any loss or appreciation, measured in the unit I choose.

The Boston Consulting Group’s famous matrix was invented in the 1970s by company founder Bruce Henderson. With a little reorganization, we can reuse the Boston Consulting Group’s growth matrix to organize all digital assets according to risk, loss, and profit risk. The four categories remain: Stars, dogs, strangers and dairy cows.

A star investment with no risk of loss but no risk of profit is rare these days, but abundant in hindsight, like regretting selling Bitcoin in 2010. Stars also exist in the performance. This was the case with investors in the Bernie Madoff Fund. But such investments quickly show up as dogs. Dogs are sure losers: there is no risk of winning, but if kept long enough the risk of losing turns into real loss.

Star investments are more common afterwards when we can no longer buy them:

The unknowns are the usual investments: they can go up or down in value depending on the day. Most digital assets, including Bitcoin, fall into this category. To the last, Cows are facilities with minimal risk of profit or loss. You are reliable. Now we can take the projects called stablecoins to see which ones really fit.

Let’s add some of the best digital assets and stablecoins to the profit and loss matrix.

Projects called algorithmic stablecoins are only in the name of stablecoins. Because of their multiple token designs, they do not carry any risk of profit – as the entire new offering is delivered to investors – but holders retain the risk of loss.

The pricing is not enough. The expected value of owning an asset can be positive or negative, but it is not zero. Another lesson is that it is important to indicate a unit when talking about value. If our unit of measure is the US dollar, then wBTC is not a stable coin. However, if we define value in terms of BTC, then wBTC is the perfect stable coin.

After all, risk assessment is difficult. I received criticism for classifying Tether (USDT) as a stablecoin due to counterparty risk.

All of these points are valid.

Except in exceptional circumstances, No stablecoin is really free from the risk of loss. Perhaps Tether is a cross between a dog and a cow.

However, It should be clear that some projects use the term “stablecoin” egregiously to put the risk of profit on investors and the risk of loss on holders. However, since no sane person would have these assets on their books, these dogs will almost certainly become extinct.

An expected stablecoin value?

Smart readers will have noticed that expected value is not just a function of the probability of loss and gain: the size of the losses and the size of the wins are equally important.

Suppose I have a fair dice. If I roll a six, I win $ 60. If I roll any other number, I lose $ 6. The expected value for rolling the die is

EV (given) = $ 60 ∗ p (profit) – $ 6 ∗ p (loss) = $ 60 ∗ (1/6) – $ 6 ∗ (5/6) = $ 5

But can we extend the concept of risk-defined stable coin to the concept of expected stable coin? In other words, is it enough that the expected value of holding an asset is zero? With the example from the above cube, this condition would be met if I only made $ 30 instead of $ 60. Hence, every time I try to convert this “DieCoin” to US dollars, there is a fifth chance that it will give me a loss of value, and one sixth of that will make me a profit. However, since the gain is much greater than the loss, they cancel each other out.

I think this could be a smart approach that can be achieved through a number of derivative contracts. However, it would lose ownership to allow holders to leave their position with minimal impact on their portfolios.

This should remind us that definitions are ultimately artifacts of a community of speakers. And I find it doubtful that quite a few people find a definition of expected value convincing.

This article does not contain any investment recommendations or recommendations. All investments and operations involve risk and readers should use their own research to make a decision.

The viewpoints, thoughts, and opinions expressed herein are those of the author alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.

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