Vitalik’s post on collateralized debt obligations for issuer-backed tokens: https://ethresear.ch/t/collateralized-debt-obligations-for-issuer-backed-tokens/525
Other stablecoinsTether Basecoin Havven
Hi everyone, welcome to Unchained. The podcast where we hear from innovators, pioneers and thought leaders in the world of blockchain and cryptocurrency. I’m your host, Laura Shin, an independent journalists covering all things crypto. If you love Unchained, be sure to let the world know with a review on Apple podcasts. Those reviews help new listeners find out about the show. Also spread the word on Facebook, Twitter, Slack, Telegram, and wherever you discussed crypto. And, don’t forget to follow me on Twitter @LauraShin.
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Today’s topic is stable coins. Here with me to discuss what has been called, “The Holy Grail” of crypto are Rune Christensen, founder of MakerDAO and Philip Rosedale, the founder of Second Life and the co-founder of High Fidelity.
Welcome Rune and Phillip. Before we dive into today’s topic, I want to have each of you explain your background. Rune, let’s start with you. You are the founder of one of the more well known stable coin projects, MakerDAO. How did you get into crypto and come to head up this project?
Rune Christensen: 00:01:23
In 2011, I first discovered Bitcoin when I saw a bitcoin address and sort of followed that trail which led me down the whole crypto rabbit hole. Then I bought into Bitcoin heavily and really got excited about crypto in general. But during the great crypto crash of 2014, I lost a lot of money from the volatility. And that’s what led me on the path towards stable coins. As I sort of felt personally, how important that’s going to be for mainstream adoption and use of cryptocurrency. So eventually, me and a number of people from various stable coin communities. From the beginning of the stable coin project as a whole, we ended up going to Ethereum and basically setting up; we try to basically make the ultimate stable coin in Ethereum because we saw this smart contract ecosystem really as the perfect place to bootstrap it, grow and grow a stable coin. We’ve been working on that for the past three years. And then finally this December 17th, we were able to launch the first consumer ready stable coin, which is now live and being used on a number of exchanges and by businesses.
Laura Shin: 00:02:50
One detail that I love about your story is that you were an English teacher in Asia, I believe, right? When you got into crypto.
Rune Christensen: 00:03:01
Yes, that’s right. I was an English teacher in China and then started an HR agency that brought in other English teachers to China and it’s basically from doing that business. It was in that context, I somehow stumbled upon Bitcoin and cryptocurrency. And, also I sold my business and invested all the profits into Bitcoin. Earning a lot of money, but then subsequently losing most of it again because of the great bubbles and crashes of the early days.
Laura Shin: 00:03:34
And so it was just that experience of losing the money that a stable coin was needed? Or, how did you come up with the idea for a stable coin?
Rune Christensen: 00:03:44
It was partly that, and then also just sort of the inherent promise of a stable coin. So stable coins were actually invented in the BitShares community. The very first design was just like a simple system where you take some cryptocurrency called BitShares and you back a stable coin that’s pegged $1 with this other cryptocurrencies. So you sort of have the collateral behind the currency. And then, what we’ve made now with Dai is basically an evolution on that concept. Where we’ve made it more powerful and we’ve solved all of its deficiencies.
Laura Shin: 00:04:28
Phillip, you actually work in another area, VR, virtual reality and founded Second Life. And then you left that and have now founded a new VR company. And what I thought about your experience that would be relevant on Unchained was what happened with Linden Dollars. So tell us about your background, but also tell us what Linden Dollars, which is what some people have called the first real virtual currency. Tell us what those were?
Philip Rosedale: 00:05:01
Thanks. Well my life has been about VR and virtual worlds. And from the time I was a kid, I wanted to build kind of open ended worlds that people could come in to from all over the world as avatars and do whatever they wanted to. And a big part of that and a big part of Second Life was establishing a currency because right from the beginning, people were building things like clothes for their avatars or furniture or things like that. And we wanted there to be a way for them to buy and sell them from each other. And so out of need, we built a digital currency called the Linden Dollar. It was introduced in about 2003 and it grew to today, a virtual economy whose value, whose gross domestic product, total transactions is about $600-700 Million a year. A few years ago it was even closer to about a billion dollars a year. A lot of people, about a million people or so a month, exchanging goods and services with each other in a virtual world where they were typically in different countries as users and they needed a way to pay each other and they needed a way to pay each other quickly in small amounts. And so we built the Linden Dollar and we built a monetary policy. And, we recognized and succeeded in making it stable, which was a very important part of allowing people to have real jobs in Second Life. And so yeah, a lot of sort of similar stuff to what we’re seeing now with crypto.
Laura Shin: 00:06:30
Yeah. And as we’ll get into later in the episode, you are doing more experiments with that. But before we get to that, let’s first define this term stable coin. What is a stable coin? How do you guys define it?
Rune Christensen: 00:06:46
I would say the very basic meaning of the word is just cryptocurrency or coin that has a stable price. So typically people, they think of it as it’s being pegged. And so it’s like a price that’s like like 1 dollar or 1 euro or something like that. But I think another definition that is also valid, it’s just one where it’s like, over time on average it’s stable against sort of the price of goods.
Philip Rosedale: 00:07:12
Yeah, I would agree. I think the goal, and certainly this was the goal with Second Life. If people are going to engage in trade, not speculation, but actually buying and selling goods and services from each other. They need to have some kind of a monetary unit which when compared to something like their rent or what they think their work is worth, changes slowly over time. So like what Rune said, something that changes slowly over time and isn’t wildly driven by things like speculation.
Laura Shin: 00:07:42
And so why do you think people call them, “The Holy Grail” of crypto? Is it because it’s difficult or because that will be the linchpin to the crypto world taking off or why is this considered such an important challenge?
Rune Christensen: 00:07:59
Yeah, I mean, right now crypto is, it’s very much about hype and speculation. And, there’s a lot of potential, a lot of promise, but it’s actually limited how much we are seeing in terms of real life implementation and real life solutions being delivered right now. And I really think one of the main things that is holding everything back is this pervasive issue of volatility. You’re just not going to be able to make some sort of a fantastic insurance application or a derivative or something if you have to design the whole thing around an asset that can change 20% over 24 hours. Instead, once we have a stable coin and there’s the stability that can be used in the trade for goods or services. Like Phillip was talking about, right? That is something that you can rely on for the everyday things that you are relating to in terms of what you spend your money on. That’s when you finally open up the types of products that can actually change everyday lives because they’ll no longer be this barrier to adoption in the form of volatility.
Philip Rosedale: 00:09:10
I think another piece to add to that is simply that, and we really saw this in Second Life and we’re seeing it with Bitcoin and Ethereum. If people believe that the future utility of a cryptocurrency of a currency is greater than it is today, and that currency is limited in numbers. They’re going to speculate correctly that it’s going to increase in value and that’s exactly what we’re seeing with Bitcoin and Ethereum, but the real world has shown us numerous times that if something is being speculated on and in particular, if it’s speculated to increase in value, it will not be used for day to day transactions. No one would buy a car or a refrigerator with Bitcoin today given that they know, they might be giving up a doubling in the value of that money over even the next month or so. And, so we’re not seeing regular transactions happening between people for goods and services, which was the original promise of Bitcoin. And so we’ve got to fix that somehow.
Laura Shin: 00:10:12
Yeah. Well that’s interesting and sort of funny because there have been a few people that have bought things like Lamborghinis with their bitcoins, but as Chris Burniske pointed out on Twitter, he was like, “Why would you do that? Because then you’re trading it for an asset that will only depreciate.”
Philip Rosedale: 00:10:31
I think the most famous one was, of course I’m not an expert on this stuff, but it was that $140 million pizza, right? The Bitcoin pizza from some years ago.
Laura Shin: 00:10:42
Right, 10,000 bitcoins were spent on two pizzas. One other thing I just wanted to throw out there when Rune was talking about how this could be important for things like insurance. Another application that people often say stable coins are necessary for is prediction markets. Which is something that everyone thinks, “this is kind of like an idea that has a lot of promise with cryptocurrency.” But you know, still it probably isn’t gonna really go anywhere if you don’t have a stable coin.
There was this recent Hacker Noon post by Haseeb Qureshi whose, I guess, an engineer at earn.com and he talked about stable coins. And in it and laid out the three main strategies for creating a stable coin. I don’t know if you guys recall the posts, but can you just sort of describe for me what are the most typical strategies?
Rune Christensen: 00:11:38
I agree with his post in general that there are three main strategies in terms of stable coins. And then the most simple one is, I guess that’s what Linden Dollars were for instance, right. And, also what’s something like Tether is and a number of other coin currencies. Where it’s basically, you just have a backing of some sort and then you have a one to one representation of that collateral. So for instance, if you have a stable coin that’s worth $1 and there are a million of those stable coins outstanding, then it means there should be a million dollars in the bank account somewhere. And that’s for instance what Tether is claiming that their stable coin does. So basically, what you’re really doing is you’re making this sort of an IOU actually that can be tracked and easily transacted between people. And the advantage of that model is that it’s very straightforward. It’s pretty easy to understand what’s going on. The disadvantage is that it’s also fully centralized. So, some would argue that it limits the potential of, for instance, its use in blockchain technology because it’s sort of like, if you use that on a prediction market for instance, then the prediction market as a whole to some degree also become centralized. So that’s the first and most basic of them.
Philip Rosedale: 00:13:06
Yeah, if I could add. Actually, what we did with Second Life was not that. We did not use the dollar peg with Second Life. What we actually did with Second Life was we created new currency and sold it on the open currency market. We, several other people, much like what we see with crypto today, there are a number of open markets where you can exchange Linden Dollars for things like the Euro or other currencies. There’s also a foreign exchange site called the Lindex, which Linden lab has of their own which allows you to exchange Linden Dollars for dollars and for Euros. The strategy we actually used was different and quite interesting. It was that as the exchange rate increased gradually as more people, as the economy grew, we actually printed more money. We did this transparently, we told everybody exactly what we were doing, everyone could see the trades we were making and we sold that new currency on the same open market. And we did that with a goal of holding the exchange rate roughly constant, as the economy grew. And that was very successful. The exchange rate of the Linden Dollar to the Dollar is about 265 to one. And it’s changed by no more than a couple of percent a month over the last decade. So it’s been a remarkably effective strategy and it didn’t use a reserve peg like Tether does.
Rune Christensen: 00:14:24
Okay. That’s actually really interesting. So there’s no reserves behind it at all? What about redemption, like if people start moving out of Linden Dollars?
Philip Rosedale: 00:14:35
So one of the really interesting things is that the Linden Dollar went through a growth from a zero, zero economy to a billion dollar a year economy over the first five years or so, and it has stayed roughly flat to slightly shrinking over the next five years or so. Interestingly enough, we never offered to redeem. We never offered any promise, to purchase currency back from people at any time during that entire phase. Those two phases, growth and then stability to slightly shrinking. And interestingly enough, and I can’t give an answer for this other than just the facts. The Linden Dollar has not weakened against the dollar, even though the economy has reduced in size by perhaps maybe 15% or so over the last few years. So Linden Lab doesn’t sell, they sell little or no currency on the open market anymore. So the money supply stays constant, but the exchange rate has actually stayed remarkably constant during that period as well.
Laura Shin: 00:15:39
Any theories as to why?
Philip Rosedale: 00:15:41
I think there’s a psychological belief that because we had stated and demonstrated a willingness to increase the money supply as a result of increasing exchange rate, it created a kind of consensual belief and a treatment of the currency as just being relatively stable. So I think it indicates that there are psychological forces as we all know, or at least armchair economist in my case. There are psychological forces that can be brought to bear that are surprisingly effective. And I think the simple fact that the money supply could change as it cannot with Bitcoin, created a broad public belief that it was a stable thing. And so it kind of made the Linden Dollar more stable than one would’ve thought even without as Rune said, the ability to buy back the currency.
Rune Christensen: 00:16:33
I was just saying that just because there is this inherent economy underneath. I mean that’s definitely gonna have a big impact on the long term, like the stuff like money velocity and those sort of things, right. Meaning that there’s just going to be this demand for the currency that’s sort of keeps it, being useful over time.
Philip Rosedale: 00:16:51
I think that’s, I couldn’t agree more. Yeah.
Laura Shin: 00:16:56
For those of you who want to hear more about velocity, that’s sort of like how quickly money changes hands in an economy over some period of time. Chris Burniske went into this in depth in the podcast I did with him in the fall and that was a really, really fascinating episode. I really urge you to listen to it.
Let’s actually continue with the other strategies for creating stable coin. So we have the one strategy that you discussed where it’s sort of like Tether, where you’re keeping dollars in reserve and so it should be fully collateralized. But I think the downside as Rune pointed out for that is that it’s more centralized, which as you know in cryptocurrency is definitely considered a big risk. So what are the other strategies?
Rune Christensen: 00:17:51
Actually the next strategy, and if you think about this recent post, descrbing these three strategies. Then this was described in the top right of the triangle and was called crypto collateralized stable coins. And, I think this is where you would say Dai and Maker falls under. However, I guess one thing that’s important to point out is that crypto can take many forms. And, really the way we call it, like what we consider this type of stable coin to be in the category. We would put Dai and Maker, it is multi collateralized stable coins. So basically, a stable coin that instead of just having like a one to one deposit in a bank account, instead it has collateral that is in many different forms and shapes. And diversified across all these different types It can be in basically. And then, most importantly, it’s always over collateralized. So for instance, if you look at 1 Dai and how and what it’s backed by currently. Instead of it being a 1 to 1 dollar in a bank account, for instance, it’s something like 3 to 1, value of Ethereum. Held into smart contract. So instead of going into a bank and then be able to retrieve $1 for your stable coin. You can go to the smart contract system and you can retrieve, well you can retrieve $1 worth of ETH, but you know that even if the price of ETH falls for instance, there’s still going to be Excess ETH available for you to retrieve. And then what’s even more crucial is that overtime, this infrastructure is expanded to support any type of asset here. So it’s not just going to be Ethereum that’ll be used as collateral. It’s also gold through various gold tokenization projects. It’s also traditional assets like stocks and bonds. And basically anything that sort of adds to the overall stability and diversification of the total collateral pool. Which then gives you this hybrid functionality where on one hand the system itself is decentralized in the same way that something like bitcoin or ether is. It’s just some code that everybody agrees on that runs the system and that’s how the fundamental monetary policy of the stable coin is governed. But then on the other hand, you do have access to these real world assets and all these various assets that are used as collateral that sort of held in virtual bank accounts so to speak. All these various places where it’s like something like Gold in Singapore or etherium on the Ethereum blockchain or US dollars in a US bank account.
Rune Christensen: 00:20:38
All of this is put together into one system and all contributing to the stability of the stable coin. And the crucial difference between this and something like Tether is that even if one of the places where collateral is deposited fails. Basically, turns out to be insolvent or something. There’s still so many other points in the system that on their own offer this over collateralized protection. That a single failure in the system doesn’t really affect the stability of the overall system and it can mitigate even relatively large crashes or unexpected events and still remain stable for the end user who can just trust it to be $1 or whatever it’s supposed to be stable against.
Laura Shin: 00:21:33
There’s one part I don’t understand. I obviously get how you can use ether to over collateralize or a crypto version of gold. But then what about something like USD dollars? Like where would you store that?
Rune Christensen: 00:21:45
Well, so actually if Tether was extremely legit and it was totally transparent. How their claim to the underlying dollars worked, then it would just be through something like Tether. However, there is another project called TrueUSD, which is making something similar. Basically, they are pretty much positioning themselves as Tether but legit, pretty much. And that’s an example of something we could use as really great collateral. Because it will be transparent for us to sort of understand the risks of it and it will allow us to add it into the autonomous smart contract system and then just have it be another node in the overall diversified portfolio.
Laura Shin: 00:22:38
And when you say Tether, but legit. They’re working with kind of known custodians around the world and everything is done in compliance with know your customer and anti money laundering regulations. So there’s kind of like a certain level of comfort that people would have in those dollars actually being in reserve. Did I characterize that correctly?
Rune Christensen: 00:22:59
Yeah, exactly. And crucially, it’s also possible to take TrueUSD and go to them with your TrueUSD and then they will give you real dollars in return, which is something that Tether used to say they offered people, but at some point they just stop actually letting anyone do that.
Laura Shin: 00:23:16
And one other thing that I wanted to add to what you’re describing here is that, am I wrong in thinking that this is somewhat similar to this concept that the IMF has, which I actually wish I had thought of this earlier when I was writing the questions, but I googled it quickly. I guess it’s called an SDR, special drawing rights. And I think it’s a basket of different currencies or something. Do you know about that? And is that similar to what you’re trying do with MakerDAO?
Rune Christensen: 00:23:53
What’s really interesting is that Dai used to be pegged to the SDR. So we used to actually be really obsessed with the IMF and the SDR and what they were doing with this currency basket. Basically because, there are some parallels there. Because it’s about how they diversify these various currencies to create a basket that’s supposed to be superior compared to any single currency. However, after doing a lot of research on sort of the actual performance of the SDR in the market, we actually came to the conclusion that there isn’t much advantage over just using the US dollar sort of as our reference of stability. So that’s why Dai is now just pegged to $1 because it’s just easier for regular people to understand and you don’t really gain much advantage in using the SDR. Which actually is a little strange, because it is possible to design currency baskets that are superior, but the SDR just isn’t designed in that way. I guess the principle of how the underlying backing and the fact that you have basket behind it isn’t exactly the same as the way Dai works with the collateral and so on, right. Because the SDR is just sort of a 1 to 1 backing and 1 to 1 peg, so to speak in exposure. Whereas in our system it’s kind of that we have this highly diversified collateral that has all these different exposures. And there can be thousands of different collateral types in the system. And, then ultimately we use all of that to back something that’s pegged to exactly $1 regardless of what’s happening to the collateral behind it. And the way we are able to enforce that is because we just always ensure this overcollateralization. So basically, it’s because there is always going to be, you know, if there’s a million dollars of Dai outstanding, there’s going to be something like $2 million worth of collateral at least or or just a large amount of collateral. So even if the collateral changes from day to day, it doesn’t impact the fact that there’s still more than $1 worth of collateral for the Dai to sort of claim. And that just ensures that Dai remains overall stable regardless of what’s going on in the market.
Philip Rosedale: 00:26:09
If I could add. Aren’t we really talking about as we look at these reserve strategies these backing strategies for different stable coins and cryptocurrencies. We’re really talking about a broader phenomenon, which has been an important part of the financial history of the whole world, which is fractional reserve banking. The bank’s ability to make loans is based on the fraction less than a hundred percent of reserves that it has to maintain. I’m struck by the observation that a lot of the stable coin design exercise is one that is very similar to the question of what fraction of deposits a bank is required to hold on account. And that’s been obviously such an important and interesting issue in world history and it seems like we’re going through it again with cryptocurrencies. I would also add that there were, in coming from Second Life, it seems to me that there are two important different types of stability. There’s seeking stability during a period of monotonic or increasing growth. And then there is seeking stability during a period of equilibrium where there are, for example, as many people using cryptocurrency as want to. And then there are all these real world currencies. It strikes me from the Second Life background that it’s very important they understand which stage you’re in. I think we’re in a stage with cryptocurrency and I bet most would agree right now, where everything is growing because for the most part cryptocurrency is as yet under utilized. And so like Second Life in its first few years, you’re going to see steady growth as people are trying to make some use of these new systems.
Laura Shin: 00:27:52
Phillip, I actually want to go back to what you were saying where you sort of compare these over collateralized stable coins to fractional reserve banking because I feel like it’s the opposite, right? You need to put up more money then you can take out, which is a really different thing from getting a loan where you don’t put anything in and you get to take something out. Right? So, I understand what you’re saying on a certain level, but I feel like the individual experiences is completely different. It’s definitely not a credit system.
Philip Rosedale: 00:28:24
Well, I guess what I’m saying is, going back to what you guys said about maybe Tether being overly centralized. If we had a transparent reckoning of dollars and euros and other currencies that were submitted for deposit in, say, a regular bank, in exchange for a certain amount of a token on a cryptocurrency. And that was done all over the world and we can publicly see a lot of different balances that would tell us essentially how large our reserves stake of US dollars overall was. Then I think we will end up with a financial system with a fractional reserve. We don’t need… I personally, although I’m not an expert on this, don’t see the reason why we would need to collateralize beyond a hundred percent. We should be able to collateralize less than a hundred percent just like we do with the regular banking system, I think.
Rune Christensen: 00:29:15
So I just want to add some here about what fraction reserve actually means. So it’s an interesting point. This, this like overcollateralization isn’t the opposite of fractional reserve for instance. So what fractional reserve actually means is how much of the reserve, how much of the bank’s collateral is held with the central bank and how much is held in the various loan agreements that the bank is doing. So what’s interesting is, and it makes perfect sense when you think about it. Is that from the point of view of a bank. Even when they’re doing fractional reserve lending, they’re still over collateralizing in the sense that they are always making sure that they have some sort of claim that they feel is enough to cover what they’re risking. Because then they’d never make a loan to someone who they feel could not possibly pay back that loan.
Laura Shin: 00:29:15
They did that before. [laughing]
Philip Rosedale: 00:29:15
They did that in 2008 [laughing]
Rune Christensen: 00:30:23
[laughing] If they are rational. But what’s interesting is that this collateral can take all sorts of strange forms. It could be like a personal liability. Like some claim on someone’s salary basically. It could be like a lien on a house which is a really typical type of collateral’s use. And then, when you’re talking about fractional reserve, it’s really like the fraction of the reserve that’s like hard reserves and the fraction that are sort of most soft collateral. And then in the context of an overcollateralized stable coin like Dai. It’s actually the exact same situation you’re in because you have to also think about this. Like how much of the collateral needs to be really hard, extremely tangible assets and how much of it can we risk basically having as more, slightly unreliable, more soft assets. That on one hand are, it’s more hard to predict what happens to them in the event of a crash for instance. But then at the same time, there’s way more of this stuff available and we can heavily overcollateralize with this kind of stuff. It’s actually a dynamic that’s very similar. And when you govern a stable coin like Dai, It’s definitely extremely important to rely on sort of the existing knowledge from the financial system. Use existing models, existing theory and especially avoid the historical blunders in the banking system, that kind of stuff. And basically make sure that we’re building on top of the knowledge that already exists.
Laura Shin: 00:32:01
Okay, so we’re gonna finish this discussion about Maker and we’re gonna also talk about Linden Dollars and some other proposals for stable coins. But first I’d like to take a quick break to tell you about our fabulous sponsor Start Engine. Interested in raising capital through a regulated ICO? Start Engine is your one stop solution. Start Engine, an ICO platform with 140,000 plus investors was founded in 2014 by Howard Marks, co founder of Activision/Blizzard. Start Engine’s mission is to help entrepreneurs raise the capital they need to succeed. Since the implementation of the jobs act in 2016, Start Engine has helped 150 companies raise capital. The emergence of cryptocurrency presents an opportunity for entrepreneurs. In 2017, ICOs generated $4 billion worth of capital. The team at Start Engine leverages their experience and expertise in crowdsale and securities regulation, to launch SEC complaint ICOs. In fact, Start Engine can help a company to build its own tokens and is creating a secondary market upon which those tokens can be traded. In short, Start Engine provides a complete token ecosystem. If your company wants to launch a regulated ICO, just go to startengine.com/unchained for a free consultation and a 20% discount on future ICO set up services. Start engine does not provide legal advice.
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Laura Shin: 00:33:31
Our topic today is stable coins and I’m speaking with Rune Christensen, founder of stable coin project MakerDAO and Philip Rosedale, the founder of VR worlds Second Life and High Fidelity. So Rune, let’s actually finished talking about Maker. One point that I wanted to make here is, I think you’re starting off with what you’re using for collateral as being ether and next year adding gold. But, I feel like the success of your project really depends on how diversified it can be, right? Because if you end up using a basket of all cryptocurrencies and then the whole crypto market crashes 90% or something, then your stable coin is not going to be so stable either. Right? So doesn’t, it sort of depend on you getting crypto versions of other kinds of assets?
Rune Christensen: 00:34:26
Yeah absolutely. And that is the one thing we are focusing the most on. It’s getting high quality, diversified collateral from all over the world. The core team is working on this a lot. Luckily, what we’re seeing is this incredible trend right now in the space that basically, a lot of projects all over the world and doing exactly what we sort of predicted and bet on. Which is just making their own platforms for scalable tokenization of securities and various assets. We also have, in the short term, we have some really interesting individual projects such as, there’s gold tokens that are actually popping up all over the world and then we’re also seeing a type of real estate token that just has a really sort of simple and straightforward legal framework that allows us to actually use tokens that have the same sort of risk profile as real estate. But, at the same time are extremely easy to use in our system without having to worry so much about the legal and regulatory framework.
Rune Christensen: 00:35:34
However, it is definitely the next step is to actually set up these strong and highly reliable regulatory frameworks that will allow us to use securities as collateral. Like I was talking about before. It’s about getting like stocks and bonds and commodities and all of this stuff, in a format where we know it’s going to be strong claims on the underlying assets. So that we can actually rely on them as a significant portion of the collateral for the stable coin. Basically, this is the challenge to get this done right. And I think right now, it’s looking really positive. In the short term, I think we will have more than enough to handle sort of the short term spikes in demand that we expect to come when we launch the fully scalable, multi collateral system this summer. But, also a clear pipeline to our end goal which is this state where the system really is exposed to assets from all over the world. And basically, every single legitimate jurisdiction has a very straightforward way to interact with our system and allow us to use assets from that particular jurisdiction to back Dai.
Laura Shin: 00:36:52
So a couple other questions I want to ask you are, we know that different central banks are looking into creating Fiat versions of cryptocurrency. Would something like a crypto version of US dollar, would that threatened makerDAO? Like would that just obviate the need for stable coins at all and render your project sort of, not useless, but you know, obsolete?
Rune Christensen: 00:37:19
So actually we are really excited about those because we see them basically as a supercharged Tether. A highly, highly reliable version of the 1 to 1 backed stable coin. First of all, they’re really, really reliable collateral in our system. And it actually ties a little bit back to the discussion on the fractional reserve, right? Because if we can get access to true central bank money as collateral, then we finally actually have an asset that is considered like true reserves in the traditional financial sense.
Laura Shin: 00:37:56
But if it is a crypto version of USD. Then won’t that mean that your project is unnecessary?
Rune Christensen: 00:38:06
Well, it’s still a claim on a centralized entity, right. The things that our system does differently is that the system itself is fully autonomous. It’s fully decentralized, it really has all the features of blockchain technology that you want something to have when you’re think about decentralized applications and that kind of stuff. I mean ultimately if you build, let’s say a decentralized prediction market, but you’re making people use, Federal Reserve US dollar token. Then ultimately, it’s not much different from just having the Federal Reserve running that prediction market, right? Because ultimately they have the ability to pull the plug on it at any time and who knows. I mean maybe prediction markets become illegal suddenly or you know, there’s just, you know, some sort of action like that could potentially make this a very big weakness in the system.
Rune Christensen: 00:39:03
I mean at the same time it’s not like these type of assets are not extremely useful because they definitely are, but there’s always going to be these different use cases for different assets depending on what their characteristics are. And, I think what we might end up seeing is something where Dai is sort of this asset that stands at the center of the entire blockchain hurricane, so to speak, like the eye of the storm. And then something like US dollar, like Federal Reserve Tokens and then of course, also tokens from every single other central bank. They sort of tie into it. But there’s still centralized. They are still at the edge of the actual decentralized ecosystem. The one thing they do really well is that they’re going to be really excellent onramps, right? It’s going to be a really good way to sort of move money out of the traditional banking system and into the decentralized ecosystem.
Laura Shin: 00:40:03
I liked the way you answered that. That is a point that’s obviously really important that I hadn’t been thinking of. One last question before we move on to Linden Dollars is I wanted to ask. So if Maker is going to be pegged to the US dollar, then that means that it will always be slightly debased every year. Right? Erik Voorhees, in one of the recent episodes, talked about this at length, but isn’t that essentially the same thing that’s going to happen to Maker or Dai?
Rune Christensen: 00:40:31
The thing is actually, the reason why Dai it’s called Dai and not something like decentralized dollars or something like that is because like I was saying earlier actually the original goal was not for it to be pegged to the dollar or any particular asset. It was for it to be just sort of stable in the fundamental sense of the word. It would just have a stable purchasing power over time, measured against goods and services. And initially we were actually looking at the SDR as the primary reference of stability. And then basically because we did a lot of quantitative measurements. We came to the conclusion that we better off just pegging it to the US dollar initially. But the plan is actually that over time if the US dollar, sort of fails to be this really well managed currency, which I admit, I mean I would say currently is a really good asset in terms of if you look at overall the performance of the various currencies around the world. US dollar right now it’s a really solid asset that people can trust. But of course it’s not guaranteed that will always be the case. And, basically our plan is to rely on the US dollar for as long as it makes sense. And then the moment that there is something like stronger inflation or hyper inflation or any sort of mismanagement of the US dollar, our system actually supports depegging at any point in time. It’s basically up to the community to decide when it happens and then implemented through voting. And once they do, they can switch to something like a diversified currency basket or something like the SDR or even something like a diversified CPI basket. So actually, it could move to something where you just measure value in terms of goods and services and don’t even think about exchange rates to other currencies.
Laura Shin: 00:42:25
This seems like a really powerful concept and it’s pretty interesting. Before we move on to Linden Dollars, we didn’t finish going through the different strategies for various stable coins, but I just want to mention in addition to TrueUSD, which Rune talked about earlier. Another project that at a lot of people are talking about is Basecoin and that has a pretty different strategy where they essentially use a smart contract as a sort of central bank that inflates or deflates the money supply based on price. And there are other actors in the system. I actually discussed this on a previous podcast. Rune, do you remember the names of the two groups? It’s like the bond holders and then there are shareholders and then the bond…
Rune Christensen: 00:43:22
The original project that stuff like Basecoin. There’s another one called Havven as well. Both of them are based on a concept called senior shares. Which is actually one of the oldest stable coin ideas. But the idea itself, which is called senior shares actually never was implemented. And then Basecoin and Havven both sort of complicated the design basically. But still remained with the fundamental same economic incentives. And so from the point of view of someone like me, who is into Maker and basically understands how Maker works and why Dai makes sense because there’s some value behind it that’s backing it, right. Which means that even if suddenly there’s a huge drop in demand for Dai and nobody wants it anymore, you can still count on it having value because you know, they’re those real assets behind it. And basically that dynamic was sort of the downfall or the problem of senior shares that meant it never got implemented. The problem is basically that if everybody suddenly at the same time just decides that they no longer wants the stable coin. They feel it’s risky, there is a run on the bank. Basically there’s just no mechanism to basically deal with it. Like the system relies on a continuous growth over time that always has to be there. Always has to be present. There always has to be these new people coming in and basically contributing to the stability of the system and if that continuous flow of newcomers stops, then there’s actually nothing left. That’s sort of the first and last line of defense is future demand for the stable coin. And that just means it can be subject to some really horrible crash conditions basically. Similar to a run on the bank where if enough people do the run on the bank, the whole bank just like collapses to zero. And everybody who weren’t fast enough, they just end up with nothing.
Laura Shin: 00:45:11
Yeah. It’s definitely one of the more kind of faith based coins in the sense that it really makes you realize that the only value that an asset has or money has, is with the value that people believe it has. But we’ll see. There is a lot of really smart people that are backing Basecoin as well. I believe Andreessen Horowitz and Union Square Ventures invested in it.
Let’s finally turn back to Linden Dollars. We did describe it a little bit early on, but I wanted to get into some of the problems that you experienced with it Philip. I read some critiques also and I actually don’t know if these turned out to have happened, but I read this critique in 2007 that predicted that Linden Dollars would eventually run a deficit because the amount of money Second Life was taking in was less than the amount of Linden Dollars it was creating. I know also eventually you ended up banning interest bearing banks in Second Life. But, I don’t know how big these problems were. In general, what did you feel was your experience with having a virtual currency and the problems that could come along with it and the challenges?
Philip Rosedale: 00:46:24
There’s so many things to say there. Let me start with interest baring banks and our bans on that. Just like fractional reserve banking. There is the legal question of how much reserve to allow. And there were numerous experimenters inside Second Life that we’re trying to set up offerings that feel a little bit like some of the ICO offerings we see today. Where they looked like poorly collateralized or unlikely to fulfill offerings in the longterm or even somewhat like Ponzi schemes. And, so we as the company operating the virtual world had to make both kind of ethical and legal decisions about what we would sort of let people do. And one of those was whether to allow different types of banking schemes with different types of reserves strategies. And so simplistically, it didn’t seem to be adding a lot of value to end users. And so for the most part, we tried not to let people do that. I say try because Second Life is a big virtual world. It’s huge. It has a million people in it. You can’t, you know, for a reasonable amount of money, sort of police everything in such a world. But we did that. As you said, the money supply, looking at this Hacker Noon article, which as you say, very well captured this idea of three types of stable coins, a Fiat collateralized, stable coin and crypto collateralized stable coin, and then a non collateralized stable coin as you just said. Basecoin is an example of the non collateralized case. Second life most accurately could also be described to be a non collateralized case for, as I said. We never established a reserve or even offered to buy back currency. We simply, built an exchange, an open exchange where people could trade it out for real currencies.
Philip Rosedale: 00:48:11
And then the only piece of monetary policy we executed was a willingness to sell additional currency, that is increase the money supply as the growth of the economy went up and the exchange rate went up. And I think that gets back to a point that I think is true about crypto. And I think it’s part of why we’re all excited about crypto, which is, in a growth stage where there’s genuine new economic utility. Goods and services being created amongst people. You want to have a different strategy for stabilizing an economy than you do under steady state where you just have say two, gold and silver fighting for share amongst investors. So Second Life was like an island that kind of came up out of the sea where we went from no economic value to a billion dollars a year of economic value in the space of three or four years and I think that’s exactly what we’re going to see with crypto.
Crypto is not going to steal money from existing ideas. It’s going to create new economic opportunities. In VR an example of that, would be people being a teacher. Somebody teaching a bunch of kids that are 10,000 miles away because she can. She can use virtual reality to put a bunch of kids in a room and teach them something. Well that teacher can charge for her services and if she’s able to do that, she’s creating new economic value and she somehow needs trading currency to be able to do that. And so I think that is the question is when you’re growing and growing rapidly, how do you increase that money supply in a way that best accommodates the new things that people are doing?
Laura Shin: 00:49:07
So how would you release new money into the system?
Philip Rosedale: 00:49:57
Well, what we’re thinking at High Fidelity right now, and I’ve written and talked about this a bit. Is that we already set up a blockchain that is a fast, low fee blockchain for people to exchange goods and services inside High Fidelity. As we look forward, and anticipate growth as High Fidelity starts to get launched and get out there. We’re going to see the same kind of economic growth amongst end users that we saw with Second Life. And so, we’re thinking about what strategy can we use as a crypto currency to increase the money supply as that growth occurs in a way that is best for the economy. And so, what we’re trying to do, what we’re thinking right now is to try to do something that is fairly similar to what we did successfully with Second Life, but in a decentralized fashion. And a portion of the Basecoin strategy, which is what you do when the economy is growing, is something that at this point does make a lot of sense to us and that is, you watch the exchange rate. As the exchange rate between the new currency and the old currencies, say the Fiat currencies goes up. You algorithmically create new money and you distribute it in some widespread means. The proposal for example from Basecoin is that you distribute it to a second class of token holders and you allow that class of people to be numerous and trade those tokens amongst themselves. You distribute the currency to them and you let them sell it back eventually on the open market. Thus putting it into circulation.
Laura Shin: 00:49:57
Is that how HFC, the High Fidelity currency is going to work?
Philip Rosedale: 00:51:40
We haven’t yet implemented that increase in the money supply algorithm, but that is what we are thinking. Is to do something very similar to Second Life where we use an oracle of some kind to watch a number of exchange rates and as you said, a basket of them is probably appropriate, like you guys were talking about. And then, we create new HFC and distribute it out to someone. Probably a second class of token holder and those tokens could be on another blockchain. You know, they can be on Ethereum for example. So that’s what we’re in the midst of designing right now.
Laura Shin: 00:51:40
And I saw on Twitter, you said something about how people in High Fidelity. That their avatars were waiting at a virtual bank for their cryptocurrency. What did that mean?
Philip Rosedale: 00:52:25
So here again, when you create a virtual world that has latent economic value, people are going to begin exchanging goods and services that they’ve never been able to exchange before, basically because it’s VR. You need some way to give out initial currency to people to get things going. You know, it’s a lot like someone immigrating to a new country. What basic things do you give that new arrival anticipating that they’re going to contribute to the economy in some ways? So one of the things that we’re doing right now is for the existing Alpha and Beta users of High Fidelity and for the new ones coming in, we literally have a bank. Of course this is just also kind of fun. Fun way to experience VR. We literally have a bank where you can go and stand in line and collect an initial small allocation of HFC. And so that’s one of the strategies that we’re doing right now to cause everyone to have a little bit of spending money in the new economy, just as we did with Second Life. And it’s the thing that we’re trying to figure out the best way to make algorithmic as the economy starts to become large.
Laura Shin: 00:53:35
So Bill Tai, who I know is a friend of yours, and for the listeners who did not hear the episode with Bill Tai, I actually think it may have been my third episode ever. He was amazing! I highly recommend you go back and listen to that episode. So Bill told me that you had some interaction with the government about, it was something like the IRS maybe contacted you when users of Second Life started making real money. What happened there? And do you feel like you learned any particular lessons around what regulatory risks stable coins might face?
Philip Rosedale: 00:54:12
Well, first, as to Bill Tai. Bill is a friend and I think is just a genius. Just one of the most brilliant guys that is thinking about every aspect of this. I’ve always, as a friend, just been delighted by Bill because he never fails to come into the room with some big thought about something in economies that I’ve never thought about before. And that’s, you know, having thought about them a good deal. And I used to call Bill my, he was the Alan Greenspan, who always had these wonderful opinions about what was happening with the Second Life economy. And in fact, he even had that name. He was Alan Greenspan Gollum because you had to have a special last name basically that sort of made you part of Second Life. That was a delight and you know, Bill was the guy that got me thinking about Bitcoin. Because, we had the virtual economy. Starting from about 2005 or 2003 when we launched. And then Bill I remember, I think was the first person who came to me and said, “You gotta look at this thing called Bitcoin because it’s pretty similar to this digital currency that Second Life has.” And so, we’ve had a lot of amazing conversations over the years and he’s been a great advisor on the things that we’re thinking about.
Philip Rosedale: 00:55:30
With respect to the IRS. One interesting observation is that because Second Life, again, as I said before, created a lot of new value. People were doing new things in Second Life and continue to. That they couldn’t do in the real world. The way the government looked at us, I think appropriately was different because we were creating new value. We weren’t, for example, letting people kind of move from doing a job in the real world to doing in the virtual world and then not paying taxes. For the most part, people were still doing their job in the real world, but they were also in the evening doing a job in the virtual world and getting paid for that. So one observation was that the government correctly I think always looked at Second Life as generating value. I was asked one time to come and actually speak before Congress about that and it was a lot of fun to just kind of try and say, this is what virtual worlds are all about. But for the most part, they were about creating new economic opportunities, not eroding existing ones. And so we actually, I think, didn’t have to deal as much with the regulatory impact because there was just a lot less to worry about with things that were being done entirely in the virtual world.
Laura Shin: 00:56:47
And Rune, do you know if stable coins face any particular regulatory risks?
Rune Christensen: 00:56:52
So what we’re seeing right now is that it’s not really being taken seriously yet, so to speak. I think actually the overall attitude towards something like stable coins and cryptocurrency, blockchain technology is very similar to what Phil was talking about, how like Second Life is creating value. It’s like a new economy, a new thing. Perhaps with the added nuance of all the ICOs creating some level of shadiness. But I think overall, there comes a point where the authorities will have to really think hard about what the impact of stable coins, and, blockchain technology will be on just like the regular financial system and the regular economy. And currently they’re not ready to do that just yet. So that leaves us a really interesting opportunity to basically be first with our own ideas. Our own suggestions for how it should be regulated and how it should be approached. But I think one thing is for sure, and that is eventually it is something that will be highly regulated and highly controlled. Because it’s simply necessary for financial markets to be like that. If you don’t do that, you know, it’ll basically be like an ICO fest forever basically. And that’s not really what we want to happen with blockchain technology. We want it to be something that actually impacts real life and just improves on the current economy.
Laura Shin: 00:58:21
I agree. Okay. We’re running out of time, but I actually want to tackle one last topic super, super fast. Vitalik wrote this blog post where he had this other idea for a sort of stable kind of coin that he described as a collateralized debt obligation for issuer backed tokens. And here’s my summary. Feel free to correct me if my understanding is wrong. A number of issuers issue dollar pegged stable coins with different levels of risk. And then those who purchased the coins with low risk, they will pay interest rates to those who purchased the coins with high risk. And the coins with different risks actually have, I think, different prices too, if I understood that correctly. What do you guys think of that idea? And is there any project that’s trying, something like that?
Rune Christensen: 00:59:10
This is really using this sort of the traditional thinking around CDOs and just applying it to stable coins specifically. But this is a technique that was used especially with mortgage back securities to sort of attempt to turn basically unstable and risky assets into some sort of financial product that itself was actually stable. Which of course at some point it’s impossible, right? Because zero times something is still zero basically. So like at some point, no matter what you do to a bunch of risky assets, you will always end up with something that’s still risky. But, if you take that idea and you apply it to stable coins, what you actually end up with some sort of supercharged extremely stable asset. Which I definitely think, I mean Vitalik’s idea is definitely, it’s interesting in the sense that you end up with something that really, it’s very close to being as stable as you could possibly ever make any sort of asset basically.
Rune Christensen: 01:00:16
I believe no one is working on right now and I think the main reason for that is that they’re basically too many drawbacks with a system like this. There is going to be a lack of liquidity and especially you have to pay a high cost for the privilege of getting this extreme stability that you would get if you purchase the safest of the stable coin CDOs. And I think overall, there’s a number of other ways to approach this way. If you’re not so interested in fungibility and liquidity, you can use insurance or similar derivatives type solutions where you just somehow try to end up with better stability. But, as a thought experiment, I think it’s very interesting because it especially shows the power of smart contracts because of how conceptually, relatively easy it is to implement this with just an oracle and some smart contracts.
Laura Shin: 01:01:19
Okay, well I will put the link to that post in the show notes. So it’s been fantastic having you both on as guests. Where can people get in touch with you or see your work?
Philip Rosedale: 01:01:35
In my case, highfidelity.com is where you can jump into our virtual world. You can download our software there and though we’re in Beta at this point, most of the important pieces of it are up and running and as an early adopter or someone interested in getting into a new virtual world and maybe making money there, feel free to visit our website and jump in there and come and find me in world and I’ll be happy to try to show you around.
Rune Christensen: 01:02:04
If you want to learn more about MakerDAO you can go to makerdao.com. Which is a website where you can just get the basic information. You can follow us on Twitter, which is just @MakerDAO to get the latest updates. And if you want, to consider joining the main community and become an active participant in the project, the first place you should go is to our subreddit. On the Reddit.com/r/MakerDAO.
Laura Shin: 01:02:31
Okay. And for DAO, that’s DAO as in decentralized autonomous organization. Well thank you both so much for coming on the show.
Philip Rosedale: 01:02:40
Thank you, Laura.
Rune Christensen: 01:02:40
Thanks a lot for having me.
Laura Shin: 01:02:42
Thanks so much for joining us today. To learn more about Rune and Phillip and stable coins, check out the notes inside your podcast episode. Also, be sure to follow me on Twitter @Laurashin. New episodes of Unchained come out every single Tuesday. If you haven’t already, rate, review and subscribe on Apple podcasts. If you liked this episode, share it with your friends on Facebook, Twitter, or Linkedin. Unchained is produced by me Laura Shin with help from Elaine Zelby and Fractal Recording. Thanks for listening.