Will Crypto Become the World’s New Reserve Currency?
(Because of the dramatic events in the Terra ecosystem, this article has been updated. For the curious, the original article can be read here.)
Since the Great Depression and the World Wars of the 20th Century the U.S. dollar has been the dominant currency worldwide. But there is no reason to believe this will continue forever. Looking at the history of fiat currencies, every 100 years or so the world’s reserve currency has changed. The country that dominates global commerce during any given period is usually the one who’s currency dominates. This time around, the winner may not be a country. Instead, the table is being set for a currency that lives on a distributed blockchain to step in as the dollar’s hegemony weakens. And because crypto technology is permissionless, decentralized, self-governing, censorship resistant, and self-perpetuating, it means that no single government or central authority can stop it.
The recent freezing of Russia central bank assets was a signal to every other country that holding dollars is not as safe as they thought. This significantly increases the pressure for the world to find an alternative to the dollar as the global reserve currency.
The growth in China’s GDP to the second largest in the world would suggest that the yuan could become next world reserve currency, however fewer than 2% of the world’s trade is currently denominated in the yuan and it isn’t increasing in parallel with their economic dominance.
Could cryptocurrencies be the alternative? From where we stand today, they have a long way to go. Though growing fast from almost nothing not long ago (see chart), the current crypto stablecoin market capitalization is a mere $155B as compared to the world’s $86T of fiat money.
If it could be a cryptocurrency, the question is whether there will be one coin that could emerge to rival the dollar. Bitcoin has the name recognition, trust and market size to be a favorite for this spot. Ethereum’s trust, stability, longevity, security and growing dominance in financial activity and NFTs could mean it has a shot. Despite their incredible volatility, there are good arguments for both. But the volatility scares most people away, which means there is a market need for a currency that retains the censorship resistance and decentralization of Bitcoin and Ethereum but is stable enough to be a store of value and worldwide unit of exchange.
I argued previously that Terra was the best candidate to fill that need. (You can read the original article here.) Why? Other blockchains have focused their efforts on making the technology safer, faster, easier or more versatile for crypto enthusiasts. In contrast, Terra’s original approach was to design something that regular people could use, often without them even knowing they’re doing so. Because of this focus on off-chain, non-crypto use cases that saved real people huge amounts of time and money, in 2021 I argued that Terra was my bet to become the go to place to spend, save and invest their money, potentially, over a long time period, giving the dollar (which is also backed by nothing) a run for its money.
This thesis was based on four core value propositions that Terra offered that differentiated it from previous algorithmic stablecoins:
1: Spending Money: Millions of people in Korea were using an app called Chai, which ran on the Terra blockchain, to pay for everyday goods. It offered merchants a lower transaction fee than other cards (typically around .5% as compared to 2–3% for other services like credit cards) and near instant settlement (typically six seconds), as opposed to traditional providers who hold the cash for a week or more. Most major economies in the world were poised to launch Chai equivalents prior to Terra’s demise.
2. Investing Money: Terra also created the Mirror protocol, which allowed people to invest in tokens that reflect the real-world price movements of assets like a stock or commodity.
3. Digital Ownership & Play: Terra became one of the most popular places for developers to build, with over 100 apps launched across defi, games, NFTs, etc., putting it among the top 5–6 chains in the world for developer activity.
4. Saving Money: Terra also created an app that allowed users to save their money in Terra. They offered an interest of 20% through an app called Anchor as a way to attract capital to the chain. The idea was to give the CAC dollars to Terra users through an artificially inflated savings rate rather than spending it on Google and Facebook ads.
Sadly, the Terra team lost sight of the broader vision and long time horizons required to build trust and attract ‘slow’ money (for playing, spending and investing, online and off), which was why the King River fund didn’t invest. Prior to Terra’s collapse, the primary use case became Anchor’s 20% yield app, with nearly 60% of all the dollars in the Terra ecosystem (aka “Total Value Locked” or TVL) parked in that one app (source: DefiLlama from May 5, 2022). This contrasted to numbers on the order of 10–15% of Terra’s TVL in Anchor as of the early months of 2021. A depeg event occurred in May 2021 and, thanks to the broad and largely off-chain use-cases for Terra (i.e. Chai), the peg was re-established. Predictably, another depeg event occurred. Except this time, with the majority of the dollars there only for the 20% yield, when the depeg began the hot money ran for the exits and the classic “run on the bank” death spiral became inevitable.
Conclusion
And so the Terra experiment in an algorithmic stablecoin has ended. Despite this collapse, there is still a market need for a world reserve currency other than the US dollar, as the recent events with Russia’s reserves demonstrates. Early in Terra’s journey, I thought algorithmic stablecoins could be the solution to this conundrum and, based on the early spread of slow-money + high value usage + offline utility, I believed that they had a better shot than any other stablecoin.
Thanks to the scale of this failed experiment, it may well be that no algorithmic stablecoin will ever gain favor again. But blockchains and stablecoins provide an answer to many of the challenges that reliance on the US dollar present. Whether these are solved by central bank digital versions of national currencies (CBDCs), non-central bank fiat-backed stable coins (like Tether or Circle’s USDC), crypto-backed stablecoins (like DAI or FRAX), or something else entirely remains to be seen.
Z.R.
NB The ideas in this and all articles published by Zebediah Rice are his own and not King River’s. King River invests in crypto assets through their digital asset fund but did not have exposure to the Terra ecosystem.
