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Is crypto too reliant on the US dollar?

Updated: Jan 20, 2022

It is not the first time the words ‘cryptocurrency’ and ‘dollar’ have been mentioned in the same sentence and, from the looks of it, neither will it be the last. In fact, only last month this blog had an article about the links between crypto and the US interest rate.

Admittedly, these two assets have an association that harks back to crypto’s initial introduction. Since then, there have been some controversial questions concerning the two of them.

Past controversies

Initially, there were concerns that crypto would undermine the US dollar and later, that it might replace the dollar as the world’s reserve currency. But nowadays there are questions over whether crypto is in fact too dependent on the US dollar.

Too reliant on the US dollar?

It is no secret that cryptocurrencies have their shortcomings, such as untenable transaction fees, and poor user experience. Despite this, until recently, it would have seemed rather far-fetched to imagine that overdependence on the US dollar could be an issue. However, it is exactly this situation that crypto currently finds itself in.

The introduction of decentralized stablecoins has been a blessing to most people in the blockchain sector. It has allowed them to hedge against the volatility in the price of cryptos like Bitcoin and Ethereum. Price stability also means that global commerce doesn’t have to worry about incorporating virtual money into their digital operations.

Despite that, the US dollar is still unsettled. The economic effects of a COVID-19 ravaged economy haven’t yet been fully felt. Debt is currently being monetized extensively and we are seeing growing economic, cultural and political divides between generations and even cities.

The U.S. as a country is precariously balanced between potential disaster and great prosperity, mirroring the situation of its currency. Recently, we saw how the U.S. Treasury’s debt issuance had industry experts cautioning that the US dollar as reserve currency was on the brink.

Held back by its inherent nature

Unlike traditional markets, crypto lacks developed financial products to hedge or escape shifts like the ones we’re seeing right now.

Think of it this way: there are other world currencies or non-USD denominated assets to inject funds into if the dollar takes a dive. The same, unfortunately, cannot be said for crypto.

In other words, crypto-assets lack protection from external factors such as political instability. Even though one of the objectives of Web 3.0 is to become free from the control of nation-states, its fate remains inextricably linked to the US dollar.

The crypto ecosystem remains tied to the global reserve currency in most, if not all, aspects of its user experience. The most feasible way out of this reliance is by embracing stablecoins backed by the other currencies like the yen, the euro, or the yuan.

The best option ... but far from straightforward

Unfortunately, there aren’t any stablecoins not backed by the US dollar that can match the power of those USD stablecoins with a daily trading volume in the range of $5M. Mariano Conti, a past member of MakerDAO, explains why this is:

The MakerDAO group developed the autonomous dollar-pegged stablecoin dai. Conti explains that the plan initially was to peg it to the IMF’s Special Drawing Right (SDR). The SDR is a weighted aggregate of five major currencies, including the British pound, the euro, the yen, and the yuan.

However, despite the fact that the group was an account between IMF nation-state members, they ultimately chose to go with the dollar. Explaining this decision, he said, “USD was chosen in the end because people think in dollars, not SDR.”

Asked whether the decision could be reverted and the stablecoin pegged to a different currency instead, Conti asserted, “The protocol is capable of changing its peg to follow another currency if needed, although the process would likely be painful.” A more effective alternative is adopting a different currency that is backed by dai.”

That is to say, base it on a new stablecoin supported by prevailing collateral. Conti went on to add, “If this starts gaining traction, a DollarDai spin-off could slowly make the underlying dai drift to an existing or new basket of currencies.”

While the decentralized yen-backed or euro-backed stablecoins present a viable recourse, they would take much longer to develop and longer still to gain the trust of the community, not to mention the time it would take to integrate them into the user experience of several decentralized applications.

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