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The Role of a Stable, Local Currency

The Role of a Stable, Local Currency

The undercurrent powering decentralized finance (DeFi)

I want to discuss stablecoin economics, in particular providing a high-level overview of (1) what stablecoins are, (2) the role we see that they play in fueling a vibrant on-chain economy, and (3) their role as a fundamental DeFi primitive that’s fueled the Cambrian explosion of DeFi protocols we’ve seen in recent months.

The idea here is to provide a high-level overview, and not an especially technical one, so as to be of use to a broad readership. I’ll also briefly, for context and full disclosure, provide a sense of how we here at Agoric, where I’m a co-founder and economist, are thinking about these topics.

What’s a stablecoin?

Essentially, a stablecoin is a digital asset that tries to maintain price parity with another asset. Typically, a stablecoin will be pegged one-to-one with the U.S. dollar, the dollar being, at least for the time being, the global reserve currency. However, the peg could be something else: a yen, a euro, a basket of currency, or even the price of gold.

The essential challenge with any peg is how best to balance money supply with money demand. Money supply is something that an issuer of currency typically has some control over, while money demand is largely out of the issuer’s control. In most cases, the issuer would be a central bank, or, in crypto, the chain or smart contract. Money demand depends on the willingness of the users to hold the currency, in order to spend, invest, or otherwise engage in economic activity.

Being cryptocurrencies, stablecoins are quite new, but we’ve already seen sizable growth with over $22 billion market cap in stablecoins. And as you can see from this chart, it’s really grown tremendously over the last several months.

Credit: Messari

What’s not visible in this chart, though, is that there are lots of different types of stablecoins, often categorized according to th...

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