Global Currency Distributions
Stablecoins and the Power Law
Power law distributions arise when feedback from an initial or critical set of events influences future events. In contrast, Normal distributions arise when a set of many independent events are considered.
Power law distributions often arise out of positive network effects. The internet is a network and these effects dominate it. Virtually all big applications of the internet are highly power law distributed (for example, social media platforms, e-commerce stores, memes).
If every country was completely isolated from every other currency, the demand for different fiat currencies in the countries would follow a normal distribution as each event would be independent of all others. There would be no ability for network effects to kick in as all participants would be unable to communicate.
On the other extreme, if we had a perfectly interconnected world then we would have a perfect network. Network effects would become the dominant actor, leading to a power law distribution of currency demand to a single or very small number of currencies.
Now of course, our current world is somewhere in the middle, our economy is increasingly globalised and connected, however each fiat jurisdiction still maintains some degree of autonomy.
The goal of crypto is to create this perfectly interconnected world. It is the "Internet of Money". Network effects will therefore dominate this environment. And what were the winners of the resulting power law distribution? ETH, BTC, and USD-pegged stablecoins.
As of March 2024 over 99% of circulating stablecoins are USD backed, which is no where near representative of the wider global fiat demand. There is an argument to be made that due to this state of affairs, crypto actually reinforces dollar hegemony. The larger the crypto economy becomes, the more dominant dollars are.
The likelihood of non-USD stablecoins from G7 or G20 countries achieving any meaningful traction is minimal. The necessary incentives for significant liquidity to accrue to them are few, whilst the regulatory and commercial obstacles are many. The market cap of USDC alone is USD $32bn at the time of writing. By contrast, EURC sits at a paltry USD $55m, despite the EU boasting a nominal GDP of $19trn+, or roughly one sixth of the global economy.
What’s the end game?
The crypto native's vision of the future is that all financial transactions are on-chain and that each year we move a small step closer to this reality. The tokenisation of Real World Assets is key to this transformation, stablecoins are just the beginning. DeFi would become the permissionless rail on which all finance operates, protocols like Uniswap and Aave would be the tools used to exchange and borrow against your assets.
The issue is the majority of people's liabilities are in the local fiat currency of wherever they reside. As we have described, there are not sufficient incentives to create this on-chain fiat infrastructure for developed economies outside of USD jurisdictions. The likelihood of a purely on-chain universe remains low, the consensus is that the two worlds are going to co-exist for a very, very long time.
What are implications of this?
Since demand cannot be served on-chain, users have been forced to go off-chain to find their required services. As a result, the crypto economy has an over reliance on centralised swapping and lending services to connect the fiat and crypto worlds (eg. FTX, Celsius).
In 2022, we saw many of these platforms collapse, highlighting the significant counterparty risks associated. Following this, the evaporation of established institutions such as Signature Bank and Silvergate, two banks that sought to meet growing demand for crypto-fiat services, and who dominated global USD-Crypto flows, caused extreme uncertainty for the entire industry.
There needs to be a way to integrate fiat currency directly into DeFi and the crypto economy in a trustless way.
Solutions
To us, the most promising solution lies with Zero Knowledge Proofs. Through ZK cryptography, we can get contextual richness, expressibility, and strict audience controls without having to align the whole of the world to a standard or even asking for the permission of the current guardians of data. It gives individuals the ability to transmit any data (even transformed) and proof of its context as long as it’s delivered somewhere over https, email, or even NFC chips embedded in physical objects.
Tools can be built on top of this technology that connect fiat with DeFi in a trustless way. We think this is a very exciting frontier that we are currently exploring with Overdraft.com