The Pawn Shop Model for Stablecoins
Editor's Note: This article comes fromGu Yanxi, published with permission.
Editor's Note: This article comes from
Gu Yanxi
, published with permission.
The recent U.S. stablecoin market is very lively. The most important event is the prosecution of Bitfinex and Tether by the New York Attorney General. This prosecution incident has led to a surge in the number of stablecoins issued based on fiat currency collateral. Another incident is that within the MakerDAO project, due to different opinions on the governance method, there are huge differences of opinion among internal personnel and personnel changes. Prior to this, the project had repeatedly raised stablecoin fees due to strong market demand for its stablecoin. Therefore, the recent market factors and regulatory factors have led to the very active stablecoin market. This has further attracted the market's attention to the stablecoin business. In fact, more and more companies are involved in issuing stablecoins. Each project party has different resources, so their business models based on stablecoins are also different. But after carefully studying the product design and business model of various current stable currency projects, in fact, the current stable currency projects are still very risky.
In my previous article (Predicting the Development Direction of Stablecoins from Monetary Theory), I proposed that future stablecoins will exist in two forms. One is a stablecoin based on digital asset collateral and generated in a distributed manner. The other is the fiat currency stable currency issued by the central banks of various countries based on their credit. In the current stablecoin market, MakerDAO is the representative of the first issuance form. In the second approach, some financial institutions go ahead of the central bank. Under the conditions permitted by financial regulations, they issue an equal number of stablecoins based on the collateralized fiat currency. Representatives of these projects include USDC, GUSD, and PAX. These two methods of issuing stablecoins each have their advantages and disadvantages. In view of the current strong demand for stablecoins in the market, the issuance business of the two stablecoins is still developing well. However, if the issuer of the stable currency cannot clearly recognize the advantages and disadvantages of the model it adopts, it is very likely that it will be in a relatively risky situation when the market changes.
I think the method of issuing stablecoins in a distributed manner based on digital asset mortgages will definitely be the main way to generate stablecoins in the future. In this sense, MakerDAO is heading in the right direction. However, this project has fundamental flaws in some key aspects, so its future development risk is still very high. The recent change of key personnel of this project due to governance issues is one of the outbreaks. Another problem is that the MakerDAO project currently only supports token issuance based on Ether mortgages. However, the market value of ether is limited, so the upper limit of the number of stablecoins issued in this way is also limited. Therefore, the business development space of this project is limited at present. Its current model of mortgages based on multiple digital assets has not yet emerged. If it can really realize the mortgage based on multiple digital assets, then this will definitely greatly increase its upper limit of currency issuance.
In terms of the upper limit of currency issuance, the business model of issuing stablecoins based on fiat currency collateral has no upper limit at all. How many dollars the user can mortgage can generate as many corresponding stable coins. Since this method is based on compliance, the stable currency issued by it will definitely be trusted by the market, so it will be very conducive to its acceptance in the market. So I always think that it is only a matter of time before the stable currency issued in this model replaces Tether. In addition, in view of the huge space for demand in the stablecoin market, the upper limit of the growth of this business model is unlimited. However, despite these advantages, this model also has its great potential risks.
First of all, the homogeneity of this business model is very strong, and the threshold is not high. There are many organizations that can do this. A differentiating factor is whether the issuer has direct custody qualifications. Issuers with escrow credentials have some advantages in terms of cost. But hosting qualifications are not very effective barriers to competition. Therefore, many institutions can participate in the issuance of legal currency stable coins in this way.
The second risk of this model is that the profit margin is very thin. The current way of issuing stablecoins neither charges minting fees nor redemption fees. The only income is the interest income generated by users mortgaging legal currency. And this income is very small. Therefore, if a well-funded issuer participates in this business, such as one of the major banks providing retail business in the United States, it will have a very large impact on the existing issuers.
The third disadvantage of this model is that when the business scales up, the cost constraints will be very prominent. In this business process, one cost that the issuer needs to pay is the transfer fee between banks. That is to say, when the user redeems the mortgaged legal currency, the issuer needs to transfer the legal currency from its own bank to the user's bank. The issuer is therefore required to pay a clearing fee for this transfer. When the business volume of this transfer is not large, the issuer can still bear this cost. But when the stable currency business develops to frequent redemption, the transfer fee will be very obvious, especially if there is no other income support.
The fourth flaw of this model is that some issuers have not organically combined the stablecoin business with its other profitable businesses. The stable currency has a wide range of applications, but it has not formed an organic combination with other businesses or the businesses it plans to develop in the future.
So for issuers who issue stablecoins in this way, can they carry out other value-added services to increase revenue based on stablecoin businesses? The answer is yes.
Mervyn King, the former governor of the Bank of England, proposed to solve the essential problems in the current currency market, and proposed that the central bank should use pawnshops to control the amount of currency that commercial banks can issue. According to this model, commercial banks should mortgage their assets to the central bank, and then the central bank will calculate the amount of money that commercial banks can safely generate after discounting the various types of assets mortgaged, and then allow commercial banks to Loans within this limit. This model can actually be used as a reference for existing issuers that issue stablecoins based on legal tender. In addition, collateral management is a means commonly used by clearing institutions to control the risks of clearing members. For example, the American Options Clearing Corporation, which I worked for before, allowed its clearing members to pledge their own assets to meet its risk reserve requirements within the scope of the collateral it recognized.
The above mechanisms can also be applied to the issuance mechanism of stable coins. Specifically, issuers currently issuing stablecoins based on fiat currency collateral can accept digital assets such as Bitcoin and Ether as collateral, and then issue a corresponding amount of fiat currency stablecoins to users after a corresponding discount rate. Since these institutions have obtained the qualifications for custody of these assets, they can completely accept the collateral of these digital assets. In this way, the issuer can charge corresponding collateral management fees or interest. These service charges are normal charges for collateral management, that is, normal charges in the pawnshop business model. The profit margin of the business income generated in this way will be much higher than the profit margin generated based on fiat currency mortgages.
