Improving Upon Stablecoins

In a growing number of jurisdictions, privately issued fiat backed stablecoins have been ruled to be securities, or as deposit account product that can only be issued by a licensed bank. This is an obvious enforcement path for governments seeking to regulate crypto trading as an investment activity. As a result, crypto exchanges are increasingly being forced to register as securities exchanges, because they use stablecoins as a currency pair (i.e. BTC/USDT), or list other tokens deemed to be securities.

Crypto exchanges seeking to avoid securities exchange registration, by de-listing all securities, will need a substitute for stablecoins. Carats are ideal—a digitized asset that is not a security, and also has low risk and low volatility. Bitcoin is far too volatile and expensive to transact. While gold backed tokens may seem ideal, they are also considered securities—shares of a commodity pool issued by a sponsor, who manages creation and redemption.

Carats also fulfill the original goals of Bitcoin, by creating a decentralized alternative to fiat money issued by governments.

Solving the Flaws Inherent to Bitcoin

The technological, social and economic flaws inherent to Bitcoin derive from it’s

  1. lack of providing a store of real value and a lack of economic substance, contributing to volatility and consumer skepticism,

  2. singular network, with inefficient proof-of-work protocol,

  3. wasteful power consumption, and negative environmental impact,

  4. lack of scalability due to high transaction costs and low transaction rate, precluding the primary intended use, as a means of payment,

  5. inelastic fixed supply, ensuring deflation, volatility and hoarding,

  6. facility of criminal use, price manipulation, wash trades and fake volume,

  7. lack of recourse for theft, inheritance or lost keys,

  8. lack of interoperability with advancing network technologies (also a strength),

  9. lack of regulatory features (also a strength, resulting in governmental repudiation),

  10. unfairness of distributions to early adopters - wealth creation without economic consumption or contribution, and the

  11. undesirable benefits to subsidized miners and rogue governments.

Diamond Standard Carats seek to address the flaws aspects of Bitcoin, by (i) having transparent asset backing of an electronically authenticated natural resource created from real economic value, (ii) agnostic use of multiple, efficient transaction networks, and (iii) regulatory oversight of the underlying asset and related securities.

Solving the Flaws Inherent to Stablecoins

Stablecoins attempt to solve the primary deficiency of Bitcoin—no store of value. The problem is that stablecoins simply repackage government fiat money, and require users to trust a sponsor that creates them at will.

Tether, and all other stablecoins have flaws, which Diamond Standard Carats address:

  1. the issuer must be trusted to issue tokens only as reserves are added

  2. fiat-backed tokens do not hedge a loss of purchasing power from inflation

  3. the issuers seeks to profit by investing the reserve, introducing risk

  4. custodians must be entrusted to safely hold the asset reserve

  5. an auditor must be trusted to confirm the reserve (if the issuer consents)

  6. a single government, IRS or judge can disable a centralized stablecoin

  7. stablecoins may be deemed securities, subject to sudden regulation.

Because of the requirement to trust the issuer, stablecoin users assume significant risk. As witnessed with Terra in 2022, once the asset-backing becomes suspect, traders can use leverage to force a liquidation. For long term holding, assuming the reserve does exist, there’s still the drawback of being pegged to a fiat currency, losing purchasing power due to inflation. Above all, the legal risk could strike very suddenly; if a stablecoin is deemed a security, it could trigger a drawn-out bankruptcy filing by the issuer with legal fees eating into the reserve.

Ultimately, stablecoin exposure to political, regulatory and market risks, and the need to interact with the banking system, could lead to a substantial loss of value triggered by market events or government action out of the control of the sponsor.

The U.S. Fed has described stablecoins as a risk to financial stability, and in 2023, the SEC and NY DFS forced Paxos, the sponsor of the #3 ranked stable coin, to unwind what they considered to be unregistered securities. In the long term, private fiat stablecoins seem almost certain to be regulated out of existence by central bank-issued alternatives.

Gold-backed tokens solve some issues above, but share many of the same deficiencies as stablecoins, because users must trust the issuer, auditor and manager of the reserve. Gold cannot be sealed with wireless blockchain hardware, and still be authenticated optically, the way diamonds can. At 600 times the weight, gold cannot be decentralized or delivered so easily. Because they can be traded electronically without relying on trust, only diamond commodities can benefit from a network-effect, where the same blockchain token is used for all varieties of transactions: spot, futures, options, equity funds, lending and currencies.

As a result, diamond commodities are uniquely positioned as the asset behind an autonomous currency for BRICS countries (Brazil, Russia, India, China, and South Africa), which are seeking to reduce their reliance on the increasingly censorship- and inflation-prone U.S. Dollar. A reserve of Diamond Standard commodities would be transparent and redeemable, and managed by the public, incentivizing adoption. Coincidentally, each BRICS country is a major player in the diamond industry.

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