The Bit Podcast Episode 15 - Lars Hoffmann & Mike Rogers
24 May 2021, by Bittrex Global Team
This week on The Bit, we’re joined by Lars Hoffmann and Mike Rogers, research analysts for The Block. Lars and Mike recently published a comprehensive report on stablecoins and what the future holds for the asset.
Here are the show notes:
[01:31] Down the Rabbit Hole
[03:10] Modern Money
[05:45] The Wide World of Stablecoins
[23:35] Prediction Time!
[27:18] A Look Around the Industry
Stephen: Hi, and welcome to The Bit, the Bittrex Global podcast, where we give you the inside scoop on all things crypto. I’m Stephen Stonberg, the CEO of Bittrex Global.
Welcome to today’s episode of The Bit, where we sit with some of the hottest names in crypto to give you an insider’s perspective on the fast moving world of cryptocurrency.
This week, I’m excited to be talking to two experts about a subject that is discussed daily in the cryptocurrency industry, and that’s stablecoins. For those of you who don’t know, stablecoins are cryptocurrencies pegged to an actual real currency, fiat money or to exchange traded commodities. For example, there’s many stablecoins where one coin or one token represents one US dollar. There’s a lot of innovation around stablecoins, many benefits to holding them. I won’t go into those just yet, since I’ll let our guests do more of the talking.
So without further ado, I’m excited today to be talking with Lars Hoffmann and Mike Rogers, both research analysts from The Block, who have recently published a research report about stablecoins titled “Stablecoins: Bridging the Network Gap Between Traditional Money and Digital Value.” Welcome to the podcast, Lars and Mike. Excited to be chatting with both of you.
Mike: Thanks, Stephen. We’re happy to be here too. And I just want to say thank you to Bittrex Global for having us on, as well as thank you to our report sponsor GMO-Trust, just because they allow us to do the research and analysis and take the time that we need to get out great products like the report and to be able to do these podcasts to share a lot of the knowledge and wisdom and insights that we get.
[01:31] Down the Rabbit Hole
Stephen: Well, we’re excited to have you here. So why don’t we get started with some of the questions.
So I always ask our guests this first question. Who got you interested in crypto and how did you buy your first Bitcoin?
Mike: Well I’ll let Lars take that one first.
Lars: Sure. I mean, I actually got into crypto in mid 2016 while I was interning for BNP Paribas on the trading floor in Frankfurt, Germany. And at the time I was thinking about where to invest and basically it was my research that drove me into crypto at the time.
I had heard of Bitcoin, obviously, previously to that in the 2013 cycle like so many. But I really got down the rabbit hole only in 2016. I bought my first Bitcoin on Kraken the same year, in November 2016.
Mike: So when I was an undergrad student, I first started to hear about Bitcoin back in 2012-2013. And some random people would just go on CNBC and talk about it. And then in 2014, when I’m in grad school, I saw the Mt. Gox hack happens and the gentlemen outside of Mt. Gox saying “Mt. Gox, where is our money?”
And I’m in grad school getting my accounting degree and I’m looking, I’m like, okay, well, thank God, I didn’t get into that Bitcoin thing. But then three years later, when I’m working in financial services in New York City at Blackstone, a buddy of mine who I always talk markets with that works at a fund, he said that he was going to be putting about 10k into Bitcoin.
And I’m like, okay, well, now that somebody is putting money on the table, I should probably start paying attention. So I made my first Coinbase account in September of 2017. And honestly, you could imagine the timing there, just got hooked right into that last part of that bull market, and haven’t really left ever since.
[03:10] Modern Money
Stephen: Awesome. But Mike, before we dive into stablecoins, let’s start from the beginning. For our audience, why don’t you discuss what are the foundational principles of modern money.
Mike: Two of the biggest topics right now in digital assets outside of Bitcoin and Ethereum, obviously, are central bank digital currencies and stablecoins.
Central bank digital currencies, I know that you had a gentleman on from PwC, back in September, and you were talking about that. That was when we dropped our first report on central bank digital currencies, the first long form one.
And it kind of reads like a book where what we just had with basically stablecoins, you can really go from the foundational principles of modern money, which are a unit of account, a medium of exchange, and a store of value.
And a lot of the electronic forms of money are mediums of exchange, and they are stores of value, but what they lack is the unit of account. And the unit of account is really what comes from the third party commitment power of central banks. And that is the root of modern money. And that is where you go from the first tier of the financial system, from the central bank, to those that have access to their balance sheet, which is all the financial institutions. And then from there, you go from the financial institutions to all the consumers and non commercial banks within the global economy.
And it’s really an interconnected chain of IOUs, with the root of all economic power coming from the central banks’ third party commitment power, which we saw as the lender of last resort, and the market maker of last resort, most recently with the COVID crisis.
And that is where things start to get very interesting because what Bitcoin allows is it allows to really make the third party commitment power not be a central bank, but actually be kind of a group of miners that are adding electricity and their computing power to basically provide that third party commitment power, and to really provide that settlement layer. So it really revolutionized things.
And from there, what we get is what we are going to be doing for the future of value storage, of value transfer that is all being built into the base layer of the internet. And that’s what a blockchain is. And that’s really kind of why we’re here, and how we got into stablecoins because we believe that those are one of the biggest pieces that are going to allow for this new era of value storage and value transfer being built directly into the internet.
[05:45] The Wide World of Stablecoins
Stephen: Well digging more into this, and it’s so complicated, and I find any conversation in blockchain or crypto you have to kind of level set.
And I think a lot of new people don’t even really understand what Bitcoin is, and a stablecoin, which is what we’re talking about today. So Lars, what are the current primary use cases for stablecoins right now?
Lars: So I think what’s important here is that the primary cause, like the primary driver and the past behavior of users on the blockchain and the investment activities of them was actually the path to fiat.
So you have a difference in cryptocurrency exchanges between crypto to crypto exchanges and crypto to fiat exchanges. An example for crypto to fiat exchanges is Coinbase, which is having its IPO today.
Stephen: Bittrex Global.
Lars: Yeah, Bittrex Global. And an example of crypto to crypto exchanges, which many might have heard already, for example, decentralization Uniswap. So in the past, it used to be that you had to or you still have to onboard into the crypto ecosystem via crypto to fiat exchange, like Bittrex, but the transferability of value between these exchanges in the crypto ecosystem, there was a gap basically.
So what happened is that stablecoins basically filled that gap. And over time, while previously most trading pairs were denominated against Bitcoin, became denominated against a stablecoin that’s called Tether USDT, which represents the one USD peg to the US dollar. So the primary use case was trading. And so it’s trading actually.
And then over time as the crypto markets have grown to include derivatives markets, both futures and options, as well as more modern innovations, like decentralized finance, DeFi, the use case of stablecoins have basically swept over from the trading world to the trading of derivatives and then to the transfer of value in the ecosystems. For example, Ethereum, I mean, stablecoins are issued on many blockchains. Ethereum is the most notable one, but also Bitcoin, also on Tron, on Solana and many other blockchains.
Stephen: So blockchain, for new listeners, it’s kind of like a settlement protocol. So there’s just different settlement protocols within the blockchain world. And that’s all these are. And you pick which one you want to use.
Lars: Yeah, without wanting to go too technical. So you have different settlement protocols. And the use cases, there really is like the transferability of money in between those basically. If you want, we can go to some stats, right?
So just to show to the listeners, maybe the explosion of usage of the stablecoins, and the supply at the start of 2020 was quite small. So it was about 6 billion equivalent in US dollars. Today, it’s about 70 billion in total supply of stablecoins. So the growth rate has been quite phenomenal.
Stephen: That’s enormous. What I find helpful just to level set, so a stablecoin, so you mentioned CBDCs. That would be if the Fed or the Chinese Central Bank, they’re all considering issuing directly digital currency.
So all that means is instead of having a piece of paper, actual currency or a note, you would have a digital token, but it would have the same value. And it’s directly issued by the Central Bank. So it should literally be the credit risk of the central bank.
In the case of these stablecoins, like Tether you mentioned, I think it’s important. Everyone talks about Tether. So there’s a company somewhere on planet Earth that issued a token called Tether. I’m not really sure, I’ve not seen the Tether white paper, I’m not really sure where that issuer is. Nobody really knows, which is slightly problematic.
But the market sort of looks the other way. But the tokens were issued. And then this company has a bank account, and it’s perported now to be Deltec Bank, which is in the Bahamas. And so every time that this issuer mints new tokens or issues new tokens, it’s supposed to go out and take the proceeds, it receives money in and then it’s supposed to then take that money and deposit it at Deltec Bank, and it’s supposed to have a one to one, basically, representation.
So the market has privately created the equivalent of a central bank digital currency until the Fed issues one. I think the difference is you have the credit risk of this company, that’s a private company that’s issued, you’re taking the risk of the bank. And you’re also taking the risk that perhaps maybe they haven’t fully collateralized it.
And that’s why there was a big problem with Tether and the New York Attorney General. I guess there’s other examples of a US dollar stablecoin, USDC, which you can talk about a bit. Mike, why don’t you talk about how stablecoins are similar to electronic money and how they can potentially be unique.
Mike: They’re potentially unique because programmability is one of the things that we’re going to be looking at in the future and basically being able to do certain things and interact and connect in ways that we haven’t been connected thus far in the past, because they are protocols built within the internet.
They’re not the same way that say a lot of the networks are set up today, where there are a lot of closed off walled garden networks, most of the protocols are open source, and they’re open blockchains. And there are ways in which developers can be incentivized to create applications and products.
And I think that that’s why these digital assets ecosystems are scaling at the pace that they are and why you can have something as Lars alluded to with Uniswap, how within a couple of years it could grow to be at one point having more volume than Coinbase, a centralized exchange. How it’s similar, though, is that it’s really following the path of a lot of the e-money evolutions from the past. I really believe that what has been will be again, what has been done will be done again, so it’s really just more efficient. It’s following the path that electronic money did in the 90s, just at a more rapid pace.
And we’re talking about it from just a global regulation standpoint. You can see that a lot of what back then was the G20 and some of the other global regulator organizations. When we did the research and we saw how they were handling electronic money back then and what the G7 is doing right now with stablecoins, there are a lot of parallels.
Stephen: Well, I think it’s interesting. I actually think stablecoins is just back to the future. If you look at your financial history, before the Fed, in the early 1900s, banks used to issue currency in this country and they didn’t all equal the dollar. And that was the problem. That was why some of the banks would go bankrupt and your dollar would be worthless.
Mike: The wildcats.
Stephen: The wildcats. If you go to Hong Kong now you’ll see the currencies issued by the two banks there, Standard Chartered and HSBC. So it’s not the Central Bank that issues the currency. So this isn’t like a new concept, having a privately issued currency.
So Lars, do you want to give us some examples of, we talked about Tether and USDC, but there’s others so do you want to give us some other examples of coins that dominate the market and how they’re being used?
Lars: I think just based on the supply, really there’s only Tether and USDC, which basically dominate the whole crypto stablecoin market right now. Binance USD has been getting up to speed there as well. But that is a white label Paxos stablecoin. So a lot of interesting things are happening there.
I think really, the main issue is that Tether is still dominating the market. As you said earlier, they did have regulatory issues in the past. They did settle, though, with the New York Attorney General recently. So that might be out of the way. But their market share actually has been declining from about close to 75% at the start of the year to now about 86%. Sorry, 68%.
So I think Tether, USDC, Binance USD. And from there, we will have to see how the other categories, the algorithmic stablecoins, might still actually make it in the future. Or the crypto collateralized stablecoins like, for example, DAI, if they can actually carve out a substantial market share in the near future.
Stephen: So on top of that, you talked about the different types of stablecoins. Do you see preferences for different coins or stablecoins in different geographic regions?
Lars: Actually, that’s quite interesting. So I think it’s important to know that USDT, Tether, actually has a big first mover advantage right? From our research, in the time zones that we can observe, on the blockchain actually, because we don’t have visibility into transactions between exchanges, or an exchange basically in a centralized ledger. So what we can observe is the on chain transactions.
And based on the volume and the time, we can actually observe that Asia has a high preference for Tether, so for USDT, and that Europe and the US or North America in general has a higher preference for USDC, so USD Coin.
Stephen: I’ve seen that. My hypothesis was always that Tether has a first mover advantage but Tether’s a truly offshore coin. So people wonder…there’s a difference between an onshore dollar, onshore US dollar, and an offshore dollar, or euro money effectively.
So Tether is euro money, it’s offshore dollars. The dollars are in a Bahamian bank, the issuer is not in the US. So I always thought that the Asian or the non US market prefers to have the US dollar without any US sort of regulatory nexus.
Whereas, as you mentioned earlier, the Europeans and the US folks do want to have the regulations. So that’s why they prefer USDC, but the Asians perhaps don’t want that because they don’t want to have a more regulated product. Do you think that’s part of it? Or is that incorrect?
Lars: Definitely. I think that that’s part of it. And we start to see that, I think, as more institutions adopt the whole crypto ecosystem, in a sense, beyond just Bitcoin. As they also launch stablecoins, like GMO for example, I think we will see Tether’s market share to continue to decline over the next few months and years as well.
Stephen: But it will grow because the whole market is growing.
Lars: The supply will grow. But the market share as a total share…
Stephen: Smaller piece of a bigger pie.
Lars: Exactly, exactly. And I think what’s important to see also here is that we already saw the rise of Bitcoin in a sense, Somalia, Nigeria, Venezuela, in places where there’s a lot of geographical turmoil within their country. Because of politics. So I think what we can also see here and expect over the next few years is that stablecoins will play an increasingly large role in those societies where there’s political turmoil.
I think what’s interesting is that earlier this year, there were pictures circulating in Causeway Bay in Hong Kong where one of the money remittances offices actually accepted Tether. And also, in general, I think for countries that have capital controls, stablecoins via Tether, via USDC, they can present an opportunity actually for the people in those countries to still interact in commerce with the people outside those regions.
So I think that’s also a quite important use case going forward. And we already see that with China, right? They have pretty tough capital controls, but the usage of Tether in China for cross border payments is gigantic.
Stephen: I agree 100% with all of that. So Lars, why don’t we dig a little bit deeper? We talked about this a bit with Tether, but what are the risks associated with stablecoins?
For example, how do we know certain stablecoins are legitimate and have the assets backing them that they say they do?
Lars: It’s really important to actually see, as you said, if they’re onshore or offshore dollars, where those dollars are basically custodies, and with which banks and where those clients are also based.
So I think for collateralized stablecoins, there’s not that much of a risk per se, as long as the actual fiat, the actual dollars behind $1 stablecoin are custodied with a legitimate bank, like for example, like a JP Morgan, or like a Goldman Sachs or like a Citibank. I think then you have the risk of the custodian, obviously, of the bank itself. But that goes into different discussions of the safety of the whole financial system.
Mike: When the market says something is worth something, I mean, then you believe it until it’s not, but you can have skepticism and until then…
Stephen: Exactly. And just like all the tokens on our exchange, we’re not making a representation about the quality of the project. We vet these things for fraud, they have to comply with regulations. But obviously, it is a case. So it is also buyer beware.
So I agree, you’re probably pretty safe with it. But just understand the risks like anything you would buy, a stock, a bond, anything, you should always look at the risks and not just the sort of default risk, the operational risk.
Mike: You’re agnostic, you’re playing the dealer role, which is to be neutral. And that’s really how a lot of people view things. That’s how we’re viewing things from an independent standpoint of our research, because we’re trying to really take out as many biases as we possibly can.
Lars: I think if we go into the rest of the other two categories, like the algorithmic stablecoins, or the crypto collateralized stablecoins, there you come into much more risky territory. I really think stablecoins as I alluded to, none of them actually succeeded so far. So there’s like the pure risk of just loss of capital. And that happened plenty of times, until today.
I think the more interesting case actually is for the crypto to be collateralized because a lot of collateral that is also in the crypto collateralized stablecoin, for example DAI. It’s actually USDT or USDC. So by extension, basically that’s an upside. They do have the safety of the fiat being custodied in a bank. At the same time, you have the downsides of that as well. But obviously, what’s more important for the crypto collateralized stablecoins is the price fluctuation risk of the crypto collateral that underpins the stablecoin as such.
So, you can basically deposit ETH, Ethereum, into the protocol and get back DAI which is a stablecoin. But depending on the fluctuation of Ethereum, actually, your collateralization ratio fluctuates as well. That’s why you over collateralize, usually, the crypto collateralized stablecoins. But that still doesn’t preclude you from being completely risk free.
If there’s a large volatility cycle and a period of high volatility, then you can still have liquidations where basically what happens is that the MakerDAO, the protocol, sells the collateral to basically even out the stablecoin.
So I think for the fiat ones, it’s basically cost custody. But for the non fiat ones, on the one hand price fluctuation as well as, obviously, just like coding smart contract risk. So most of these programs basically run on blockchains. And there can be exploits, there can be hacks, as has happened in the past.
So they’re obviously much more risky. And I don’t think in any shape or form right now suitable for institutions. But that might change in the future as well. As we get more used to them as they custody more assets and as the ecosystem continues to grow.
Stephen: Exactly. So I think we’re trying to highlight the risks. And I think, again, because blockchain itself is so new, there’s so many new risks that are introduced into the asset class that a lot of investors don’t understand yet, which I think leads to our next question quite well.
So Mike, where do you see stablecoin regulation going in the next few years, because obviously, the regulators will try to control these risks.
Mike: The G7, one of the biggest regulators that’s affiliated with the Bank for International Settlements. They don’t even call stablecoins by the name stablecoins, they call them “so-called stablecoins.” And a lot of that has to do with they don’t want to recognize it quite yet as a form of money, or even a coin, because they understand a lot of what you understand, Stephen, a lot of what people in financial services understand is that there is a lot more risk involved in some of these areas than most people would think.
Until this gets cleared up and there’s standardization and more assurances, from a regulatory standpoint, which we’re starting to see here in the US, which is great. A lot of these trust companies are applying for banking licenses, and they’re being converted into banks, where they can have access to some of the things that not other companies that are just FinTech companies can have, FDIC collateralization insurance and access to the Fed’s discount window, as well as their balance sheet.
And I think that that’s kind of where we’re going to be heading with all this in the future. We’re already seeing it over in Europe, with the Bank of England where other companies outside of commercial banks are starting to get access to the central bank balance sheet.
And I think that that’s kind of where we’re heading because banks don’t innovate well. We know this. It’s no secret. And the financial technology companies and the technology companies in general, as Andreessen Horowitz likes to say, software is eating the world. And it’s so true.
Stephen: Well, I think Coinbase being worth more than Goldman Sachs in three to five years versus 120 years. I think that says it all right?
Mike: Yes, it does. Because you know, talent and resources and you can’t be the passion in this industry. I mean, we’re dedicating our lives to it. I’ve never felt so alive. I’m about to be a young 30…
Stephen: But in crypto years you’re like 60. Dog years, right?
Mike: It’s like dog years on hyper loop.
[23:35] Prediction Time!
Stephen: Just to sort of wrap things up, this has been really interesting. A couple more questions.
You kind of started a bit but I guess where do both of you see stablecoins going in the next 5 or 10 years, which again, like in crypto that’s like 100 years. But I guess let’s say five years is about all you can look at. What do you think the market looks like?
Lars: So I think in five years time it will rival basically the credit card system that we have, MasterCard, Visa card. And we already see that they get engaged with stablecoins. It was recently announced where basically I think Visa cards will clear USDC with the network. So definitely in the trillions per year for transaction volume.
As for the supply side, I think it will be interesting to see how non USD stablecoins will develop. As Mike said earlier and as we highlighted, right now about 99.5% of the issued stablecoins are actually packed against USD. So I think with GMO for example, there with the JPY, we will also see euro backed stablecoins. How that supply in total will pack out, right now we have like 70 billion, in the trillions as well in the next five years.
For me personally, the most interesting development will be if the crypto collateralized stablecoins, if they actually take off in size, like MakerDAO project with DAI. If you can actually rival fiat collateralized stablecoins, at least in transactional volume, if not even supply. But that remains to be seen.
I think these are the three developments. One, transaction volume per year in the trillions, rivaling credit cards. Two, supply being as well as in the trillions. And three, maybe the crypto collateralized stablecoins as a personal hope there that they will also still play a very relevant role, if not even a more dominant role than they play today.
But there will still be, I think, less dominant as a market share and total supply than the fiat collateralized stablecoins. But I think all of this also depends on the CBDCs, obviously. China might launch their CBDC this year, next year.
Stephen: Maybe we’ll all be trading digital Yuan.
Mike: The International Monetary Fund has kind of a proposal for synthetic central bank digital currency, which is basically why reinvent the wheel? Why not have what we have today, which is the two tier monetary system.
So basically have central bank digital currencies at tier one between the central bank and those that have access to the central bank balance sheet. But instead of it just being commercial banks, let’s open up that balance sheet and these accounts to some of these FinTech companies and technology companies as well as the financial institutions.
And then from there, we can let those that innovate and really do things so well and aren’t as pure bureaucratic, I guess you could say, and that are motivated, let them develop what needs to be developed from an innovation standpoint from infrastructure, as well as the instrument standpoint, let them develop that with stablecoins at tier two. So from those that have access to the central bank to basically everybody else that is within society, from businesses to just regular citizens.
And I think that that really is where we’re heading. It makes the most sense in my mind. And from that standpoint, that would mean that a lot more technology companies, as well as financial institutions will launch their own stablecoins over the next five to 10 years. Again, the US dollar has such a big presence within this ecosystem. So it will continue to be so probably well into the next 10 to 20 years.
[27:18] A Look Around the Industry
Stephen: I agree with all that. Great. And then the final question in the podcast. Tell us about one crypto or blockchain project outside of stablecoins that genuinely interests you.
Lars: I think for me, it’s Aave protocols, as lending markets basically on Ethereum. And what we’re starting to see happen there is that you have peer to peer lending markets, where basically, you can deposit collateral in a pool. And there’s another person that can take a credit from that pool, again, over collateralized, similar to the MakerDAO concept. But you can take loans on the blockchain. And I think that that’s very innovative, that’s ingenious.
And also it’s democratizing finance in a way that right now, we don’t really have. I mean, imagine you just take another mortgage with your bank. I mean, yeah, the leverage ratio, obviously, is a different one. But the whole documents you need to get through there. And the time. Just an effort compared to just going to the blockchain.
If you have crypto ready, you can take loans worth literally hundreds of thousands, if not even millions, just with a drop of a button. So I think that’s very interesting for me, very interesting.
And I think overall, DeFi will develop in the next few years to certainly rival the traditional financial system. I don’t think it will replace it yet, but at least it will rival it in certain aspects. And I think this is a very interesting ecosystem for the audience to get their heads around.
Mike: I am starting to get interested, and Lars is going to love hearing this, more in decentralized finance, because I can see that it’s here to stay.
And a good friend of mine that I met over the past couple of years journey, Windra Thio, he actually works for Element Finance, a fixed rate lending protocol, and they recently raised $4.4 million from Andreessen Horowitz and Placeholder Venture, so I’m starting to really look into Element Finance. I think they’re going to be doing some really cool things.
Stephen: Great. Well, I think this has been hugely interesting. We could go on for hours. Unfortunately, we don’t have that kind of time. But thanks, Lars and Mike for coming on the podcast, talking with us about stablecoins. Really looking forward to hearing more great news for your project. Thank you so much for listing on Bittrex Global.
Thanks for listening to The Bit, the Bittrex Global podcast. Our guests today were Lars Hoffmann and Mike Rogers, research analysts from The Block. To learn more about the Block, visit www.theblockcrypto.com. And check out their recent report on stablecoins titled quote, “Stablecoins: Bridging the Network Gap Between Traditional Money and Digital Value.”
To learn more about Bittrex Global visit global.bittrex.com. And please make sure to subscribe to our podcast. You can find us wherever you get your podcast. Thank you for listening and making The Bit one of the fastest growing podcasts in the world of crypto. I’m Stephen Stonberg, the CEO of Bittrex Global.