Since the announcement of the Taro protocol by Lightning Labs, the subject of stablecoins issued directly on the Bitcoin blockchain has once again become the center of conversation. In reality this is not something new. Tether, the first stablecoin, was originally issued on the Bitcoin blockchain using the Mastercoin (now called Omni) protocol which allowed other tokens to be issued on the Bitcoin blockchain. Stablecoins literally started on the Bitcoin network, but due to block size limit constraints and the fee event in 2017, they migrated to other blockchains. It started with Ethereum, then proliferated into more centralized and cheaper fee blockchains over time. Ultimately, centrally issued stablecoins are centralized, and no matter how decentralized the blockchain you issue them on, their value ultimately derives from the ability to redeem them from a single centralized entity. who can refuse to do so. That is, their issuance on a decentralized blockchain is complete theater in the sense that it does nothing to decentralize the stablecoins themselves; the only advantage to doing so is the ease of interoperability with the native elements of this blockchain.
I actually think the progression to other blockchains was a good thing, there is no real benefit to processing stablecoin transactions on the bitcoin blockchain in terms of censorship resistance. The issuer can simply refuse to redeem coins involved in illicit activity, coins that have been stolen, or for any arbitrary reason on which they have a legal basis to act. Their issuance and transaction on bitcoin only consumes block space which offers no real censorship resistance for stablecoins, and only provides a marginal benefit by making things like atomic swaps for bitcoin slightly less complex.
It does, however, introduce new variables into the incentive structure of the Bitcoin system as a whole. There have been discussions about the influence of stablecoins on the consensus layer of the Ethereum network in relation to the upcoming merger and transition to proof-of-stake. Circle, the issuer of USDC, announced that it will only support USDC and honor redemptions on the PoS network. They will ignore and refuse to honor redemption requests for USDC on any other fork of the Ethereum network after the merger. This is completely rational – USDC is a reserve-backed stablecoin pegged to actual bank dollars held in reserve by Circle. Honoring redemptions from more than one side of a fork is complete nonsense and impossible, as they only have enough dollars in reserve to redeem a single set of stablecoins issued on a network. When this network forks, it does not magically double reserve dollars like it does for USDC tokens on this network.
This dynamic, however, gives stablecoin issuers an outsized influence over the consensus of the network on which they issued their coins. USDC is a huge utility and transaction volume engine for Ethereum. All Ethereum users transacting with USDC will have no choice after the merge and fork but to switch to this chain in order to use their UDSC, regardless of their feelings or attitudes regarding PoW in relation to PoS, or splitting in general and what chain they would like to use. In order to use their USDC they must interact with the PoS chain. This creates a kind of mandatory demand for this token, as it is necessary to pay transaction fees to use USDC.
Stablecoins issued on Bitcoin will create exactly the same dynamic. If Taro, or even the original Omni Tether token making a resurgence, leads to the widespread issuance and transaction of stablecoins on the Bitcoin blockchain, the issuers of those stablecoins have exactly the same leverage to throw away in the event of forks. Bitcoin. If bitcoin becomes a widely adopted platform for issuing and using stablecoins, it becomes a major driver for both the demand for bitcoin itself – as it is required to pay transaction fees – and income from miners – again, as it pays transaction fees. All of this demand for the asset and revenue generation for miners becomes hostage to the whims of the stablecoin issuer.
In the event of a fork, all of this demand and miner earnings are transferred to the fork on which the issuer decides to honor redemptions. This can happen during a chainsplit, hard fork, or even soft fork if the issuer decides a feature is undesirable and commits to a fork to prevent its activation . The more stablecoins are a demand driver for the asset and block space, the more effect they have in such an event. If 10% of the miners’ revenue is to use stablecoins, in a fork where the issuer chooses a different side from everyone else, 10% of the miners’ hashpower will have to go to that fork to keep that stream of income. If it’s 40%, 40% of the hash power will have to change.
The same is true for Lightning Node operators in terms of routing royalty revenue. If a lot of the activity on the network is driven by people exchanging BTC for stablecoins at the edges and routing dollar payments, then all of that revenue will dry up on the side of a range for which coin issuers stables do not honor redemptions. These node operators will need to run and operate nodes on the other fork in order to earn these revenues from using stablecoins.
Bitcoin is not magically immune to the problems that Ethereum has experienced due to the dominance of stablecoin usage on the network simply because it does not have a complicated and insecure scripting system, or that there are no on-chain decentralized exchanges used every day. The problems Ethereum faces in this regard are purely rooted in economic incentives and apply equally well to the Bitcoin network.
Bitcoiners should think long and hard about whether they should encourage and use such systems built directly on Bitcoin, and whether the risks of such systems are worth it in the long run given how they interact with the incentives of the network. Other blockchains exist, even systems like Elements (on which the Liquid codebase is based) exist that can leverage quasi-centralized blockchains. Atomic swaps aren’t that difficult. Tools exist to build systems for stablecoins that can host them externally to the Bitcoin network and allow easy interaction with it.
Do we really want to introduce a massive new, centrally controlled variable into the network-wide incentives just because atomic swaps on one blockchain are slightly easier than atomic swaps on two blockchains? I can only speak for myself, but I don’t.
This is a guest post from Shinobi. The opinions expressed are entirely their own and do not necessarily reflect those of BTC Inc or Bitcoin Magazine.