Translation of an article by Eric Walla, Chief Investment Officer at Arcane Assets. Due to volatility, many Bitcoin users often ...
Translation of an article by Eric Walla, Chief Investment Officer at Arcane Assets.
Due to volatility, many Bitcoin users often use so-called stablecoins, the value of which is pegged to the US dollar.
The stablecoin market is growing rapidly today. The purpose of this article is to educate the reader about the potential risks and level of confidentiality of these assets.
Let's take a little time first to understand the role of stablecoins in the global economy. The Argentine peso lost about 40% of its value against the dollar in 2019. In one week in August, it lost 17.6%. Further deterioration of the situation led to the fact that the country tightened capital controls. Essentially, the government forced Argentines to keep a currency that was rapidly losing its value.
Despite the fact that the US dollar has lost 93% of its value over the past 100 years, there are currently not many assets that can compete with it in terms of stability in the short and medium term. Cryptocurrencies such as bitcoin are gaining popularity among those who understand the problems of issuing fiat currencies, but among stable assets, the dollar is still the preferred choice of many people in Latin America and far beyond its borders.
However, the tokenized dollar does not challenge the existing financial system. Such a token does not violate the global dollar hegemony and does not provide people with an alternative to the Fed's “printing press”. It gives stability. Stablecoins (at least some of them) democratize access to this stability.
Most digital dollars exist in a centralized system that almost always requires personal information to be accessed. The owners of such systems, in turn, are subject to the regulation of the jurisdictions in which they operate. Thus, they are practically useless in regions where the use of the dollar is prohibited or severely restricted due to sanctions.
Since blockchains usually do not require the provision of personal data, stablecoins can theoretically be stored by completely anonymous users.
In this article, we will focus on two main categories of stablecoins:
- Backed by fiat . This is the largest category and has a relatively simple structure - their issuer keeps US dollars in the traditional banking system; for every dollar, it issues a token (stablecoin).
- Algorithmic. These include the Dai stablecoin, which is backed by Ether and other cryptoassets; a stable price of $ 1 is provided by the Ethereum smart contract system.
These stablecoins can be stored pseudonymously. This means you can get them anywhere in the world and store them without a bank account or even a passport.
This also means that it will not be so easy to collect them. As with the purchase of cryptocurrency, it is not necessary (depending on your method of acquisition) that there will be a record somewhere that will confirm that you are the owner of these stablecoins, and the thief who searches your house may not find anything there. As with cryptocurrencies, all you need to restore access to your stablecoins is a private key that can be generated using 12 memorized words (seeds).
However, stablecoins carry a number of risks that can render them worthless (or at least they can lose a significant portion of their value).
USDT, USDC, TUSD, PAX and BUSD risks
Freeze assets
To work with regulators, many stablecoin issuers can freeze funds held at specific addresses. This feature is especially useful in case of a hacked exchange, but it also requires a high level of trust in the stablecoin issuer.
A stablecoin from one issuer can exist on several different blockchains (for example, USDT from Tether). So, USDT on Bitcoin was frozen by Tether (this functionality was added in the release of Omni Core v0.3.0 on December 11, 2017) after the company lost $ 30 million as a result of a hack.
The USDT parameter on Omni, which indicates that the token can be blocked by the issuer.
It is important to consider what technical capabilities stablecoin issuers have, but it is also important to understand how often they use this power. For example, Tether only froze USDT on 16 different addresses (USDT-Omni and USDT-ETH).
However, we cannot say anything for sure about whether USDT-Tron, USDT-EOS, or TUSD-Binance were ever frozen, as these stablecoin options are not fully open source. Also, Tether did not add the USDT freeze feature to the Liquid sidechain.
However, it should be borne in mind that although Tether itself cannot freeze USDT on Liquid, it can ask five companies (⅓ Liquid operators) to freeze assets.
Reserves
The second risk of storing USDT, USDC, TUSD, PAX, BUSD is associated with the actual security of tokens 1: 1. Tether is a prime example of what can go wrong here.
There is also always a risk that the stablecoin issuer will misappropriate the users' assets or the partner bank will go bankrupt.
Bob McElrath writes in his article "On (In) Stability of Stablecoins":
“Financial companies don't like having a lot of capital on their balance sheets - it's often called 'stuck'; they believe that it can be used much more productively (for example, this money can be lent to someone). "
To allay these doubts, almost all major stablecoin issuers (with the exception of Tether) have contracted with leading accounting firms to certify their reserves monthly ( USDC , PAX , TUSD and BUSD ).
The traditional banking system requires KYC / AML to exchange stablecoins for dollars, but this redemption is usually avoided by exchanging stablecoins for other commodities, fiat or cryptocurrency at their face value.
Dai risks
The Dai stablecoin is a product of the Ethereum smart contract system MakerDAO. Dai does not rely on strict 1: 1 dollar collateral from any bank; also there is no way to freeze funds.
Instead, Dai's stability ($ 1 per token) is provided by a number of relatively complex - albeit technically transparent - components that interact with each other. These components include:
- A leveraged lending facility called “vaults” that allows users to deposit an asset (eg ether) as collateral and “print” Dai for themselves;
- A network of 14 oracles that transmit price data and alert oracles ;
- A second token called MKR, which is used to vote for certain system parameters (for example, interest rates);
- Automated liquidation and auction mechanism.
For the purposes of this article, you don't need to understand exactly how Dai works; we only need to know about the risks of this system.
The main issues of concern regarding Dai are as follows:
Economic model
The economic model is new and experimental, but has performed quite well even in the face of significant market volatility.
Also, all assets on the blockchain carry certain technical risks, and even more so complex smart contract systems such as MakerDAO. MakerDAO smart contracts have been audited by Trail of Bits (link).
Quality of management
Overall, the value of Dai is in the hands of the MakerDAO system managers (MKR token holders). This makes it difficult to predict how well the project will perform in the future. The MKR distribution plays an important role in this, but it is not that great (source: 1 , 2 ). It should be borne in mind that voting-based systems can be attacked through vote-buying.
Stablecoin privacy
USDT to Liquid
✓ Can't be frozen ✗ Monthly audits ✓ Privacy tools
USDT on Liquid is linked to the troubled issuer Tether and operates on a centralized sidechain. However, this stablecoin (like Dai) cannot be frozen and is the only one with the tools to ensure a high level of privacy. Confidential Transactions support hides the asset type and amount of each transaction.
Liquid can be accessed through Blockstream's Green mobile wallet, which can connect to the Liquid network via Tor (using Blockstream's servers or its full node). The mobile wallet uses a 2FA scheme that transmits certain information (sensitive transaction outputs) to Green's servers whether you are using your own full node or not.
Liquid have one significant privacy flaw: while the amounts and types of assets are hidden, the transactions themselves are not. This means that the blockchain analyst can at least try to determine who is trading with whom. Leaking information through 2FA in Green exacerbates this problem as it allows all of your transactions to be linked to each other.
DAI on Ethereum
✓ Can't be frozen ✓ No audit needed ✗ Privacy tools
One of the biggest problems with Dai as it stands is that it has little to offer in terms of privacy. Ethereum's blockchain account model encourages address reuse, which means that most Ethereum users make all their transactions (including Dai) to the same address on the blockchain (making Chainalysis a lot easier). Here is a short list of technologies under development that could help address many of Dai's privacy concerns:
- AZTEC protocol - zero knowledge proof-based privacy system for Ethereum;
- Tornado.cash - Ethereum mixer;
- ZkDai - Private DAI transactions on Ethereum using zk-SNARK.
USDC / TUSD / PAX / BUSD on Ethereum
✗ Cannot be frozen ✓ Monthly audit ✗ Privacy tools
Each of these stablecoins undergoes a monthly dollar reserve review. Stablecoins themselves are ERC-20 tokens, so in terms of privacy they are identical to Dai.
Other stablecoin projects with a higher level of privacy to look out for:
