Podcast: Lipton on (un)stablecoins and FX market-making

Stablecoins are supposed to be the closest thing to a safe haven in the crypto markets. The collapse of TerraUSD, an algorithmic stablecoin that lost nearly 80% of its value this week before partially recovering, has thrown that idea into doubt – sending shockwaves through the entire cryptocurrency ecosystem.

Terra’s meltdown came as no surprise to Alex Lipton, global head of research and development at the Abu Dhabi Investment Authority, and our guest for this episode of Quantcast. “Algorithmic stabilisation is nearly impossible,” he says.

Stablecoins are expected to trade at parity with a fiat currency – typically the US dollar. Some maintain their peg by holding collateral denominated in the underlying currency. Others, like TerraUSD, are stabilised dynamically by an algorithm that buys or sells the stablecoin as it falls and rises. Lipton argues that approach was always doomed to fail.

His views on algorithmic stablecoins are not new. Lipton’s concerns were laid in his eerily prophetic 2021 book, Blockchain and distributed ledgers: mathematics, technology, economics, co-written with Adrien Treccani. “The idea of dynamic stabilisation of a coin contradicts common sense and historical experience,” the authors wrote.

The events of this week have proved him right. Terra “was designed poorly” from the outset, Lipton says, adding: “I'm surprised by the vigour with which promoters and their backers jump on these ideas.”

His criticism of algorithmic stablecoins notwithstanding, Lipton remains a strong proponent of distributed ledgers. “I have good expectations regarding some of the application of decentralised finance like, for example, automated market-makers and decentralised exchanges,” he says.

He sees vast opportunities to translate financial documents into smart contracts that can self-administer and execute transactions. He singles out carbon credits as one instrument that can be drastically improved by converting it into a smart contract.

In this podcast, Lipton also discusses his recent paper with Artur Sepp – head of systematic solutions and portfolio construction at Sygnum Bank – on automated market-making in FX.

The paper describes how central bank digital currencies or stablecoins can be exchanged through a smart contract on the blockchain while retaining pricing consistent with a traditional centralised market. Lipton argues the approach would make FX markets more transparent, retaining the monetary incentives for market-makers while improving efficiency for other players. It also has the advantage of allowing direct exchange of relatively illiquid currencies without the need for US dollar transactions.

Promisingly, Lipton reveals, some central banks are already looking to apply this form of automated market-making in currency markets.

To hear the full interview, listen in the player above, or download. Future podcasts in our Quantcast series will be uploaded to Risk.net. You can also visit the main page here to access all tracks, or go to the iTunes store or Google Podcasts to listen and subscribe.

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Index:

00:00 Introduction

05:00 Automated FX market-making

09:10 On-chain and off-chain interaction

11:25 Applications of the framework

12:25 The problems with algorithmic stablecoins

20:00 The collapse of TerraUSD

22:55 Viable blockchain applications in finance

29:30 The limits of DeFi

34:35 Non-financial applications