Fiatcoins want to be aggregators, aggregators centralize power

Fiatcoins (regulated stablecoins) have dominated conversations these last few weeks with Gemini, Paxos, Coinbase and Circle releasing USD-backed stablecoins. As I’ve written previously, while fiatcoins offer substantial benefits over fiat (e.g. programmability, transferability), they come with the steep cost of potential censorship. But censorship isn’t a business model in and of itself, what is the incentive for businesses to launch fiatcoins?

If a fiatcoin is successful, it aggregates user demand for the applications (financial, web, and other) of public blockchains. Users must visit the issuer to exchange fiat for fiatcoin and vice versa. This pools demand around the issuer–demand they can monetize by directing their users to first-party applications (e.g. exchange, wallet, apps) and demand they can control by surveillance and censorship.

This move comes straight from the web2 playbook. The tech giants print money by aggregating demand. This strategy so well describes the business dynamics of web2 that Ben Thompson coined the term “Aggregation Theory”1, which can be summed up as: the internet allows companies to directly serve users with zero marginal cost, so the winning business model is to aggregate user demand2.

Viewed through this lens, the language used by Gemini in their announcement of GUSD is telling. They aim to “build a bridge to the future of money.” With any luck, their bridge is the one that all users have to cross, just like the App Store, Amazon, and Google Search are a bridge to their use-cases of their respective platforms.

In this post, I want to explore the incentives of fiatcoin issuers and the possible impact of a winning fiatcoin.

How a fiatcoin becomes an aggregator

It’s not obvious that fiatcoins could be aggregators. Aggregators imply winner-takes-all. The fierce competition and relatively low differentiation of stablecoins (especially between fiatcoins) suggest high fragmentation. Perhaps fragmentation is equilibrium for stablecoins.

I don’t think that’s likely.

The dominance of any given fiatcoin leads to a feedback loop further increasing the dominance of that fiatcoin. A user is likely to find the issuer that is most popular. The most popular fiatcoin will have the most liquidity, brand awareness, and adoption from applications. These properties make the fiatcoin more popular. And more popularity makes the fiatcoin even more popular.

As more users adopt that fiatcoin, the first-party ecosystem around the fiatcoin strengthens:

  • A user exchanges fiat for a fiatcoin from an issuer

  • As part of the process, the user verifies their identity and creates a wallet with the issuer

  • Now the user can use the fiatcoin as they wish, as long as it’s within the rules of the issuer

  • Later, they come back to the issuer to exchange fiatcoin for fiat

Now, the issuer has a growing database of identity-verified individuals using first-party applications (exchanges, wallets, browsers) and can become a web2 aggregator–a one-stop shop for all decentralized finance and web needs. Add a service that allows developers to accept credit card payments through the fiatcoin issuer and you have a third-party ecosystem driving adoption to your aggregator!

With a dominant fiatcoin and a dominant ecosystem of first-party apps, developers are now dealing with an aggregator just like Facebook, which, as we know, is not a good deal in the long run3.

Impact of fiatcoins on applications

The greatest benefit of fiatcoins for applications is a larger user-base. I wrote in last week’s member’s post:

ERC20 digital fiat is useful in the Ethereum ecosystem. If Coinbase, Gemini, and Paxos are successful in getting users onboarded to their digital fiats, dapps have a substantially larger crypto-onboarded userbase.

The total addressable market (TAM) of dapp users is very small. For a dapp to onboard a new, non-crypto user, they have to move them through the funnel below:

Crypto on-boarding funnel:

  1. All people

  2. People that have bought crypto

  3. People that have a wallet

  4. People that have used a dapp

  5. People that have used your dapp

Fiatcoins could substantially improve the conversion from step 2 to 3. Right now, setting up an Ethereum wallet and transacting with a volatile cryptoasset is scary. Using something more familiar–a digital version of the US Dollar you know and love–eases the friction.

The same familiarity could also improve conversion from step 3 to 4. A programmable fiat lets developers offer features that mirror those in legacy systems–particularly in financial applications like exchanges and lending.

Most importantly, the issuers of these fiatcoins could offer a service that enables developers to accept fiat directly. Users at the top of the funnel could swipe their card and instantly be using the application, skipping steps 2-4 of the funnel. I’m sure fiatcoin issuers are working on this service already.

The greatest costs of fiatcoins are censorship. Fiatcoins are easy to surveil because each new fiatcoin is born to a KYC’d4 owner, making it easier to run forensics on the transactions of a fiatcoin. They also contain functions that allow the issuer to seize coins and blacklist addresses from the network. Surveillance plus censorship places a lot of power in the hands of the issuer–more, in some ways, than any given state issuer of regular fiat.

For developers, there is an ethos problem and a practical problem. The ethos problem is obvious: those seeking to build systems that more equitably distribute power shouldn’t support a form of money that is controlled by one operator. The practical problem is that in the short run (and maybe foreseeable future), accepting a fiatcoin probably helps the developer more than it hurts. But they are placing their destiny in the hands of an aggregator, which works out well until inevitably, it does not5.

If a developer can get 10x more users by using fiatcoins, should they do it?

By and large, the answer is probably yes if there is a path to fiatcoin independence. But I’m not sure there is.

Fiatcoin independence

You might be thinking, this doesn’t seem like a big deal if you can eventually swap out the fiatcoin for a cryptocurrency (e.g. Bitcoin, Ethereum) or a censorship-resistant stablecoin. From a technical perspective, find and replacing fiatcoins for something less censorable across an ecosystem shouldn’t be that hard. And I think that’s right.

But pay attention to the incentives. Championing a fiatcoin gives an issuer power. Power leads to earning money. Earning money is the issuer’s fiduciary duty to its shareholders.

The only force that will convince the eventual fiatcoin winner to abdicate power is a market that prefers something else. And because most people don’t think they need censorship resistance–it’s the marginalized that do–it’s entirely possible that the majority of the market will prefer the familiarity and ease-of-use of fiatcoins and the first-party ecosystems surrounding them.

Niall Ferguson, a historian I admire, spoke at an event I attended a couple weeks ago. Feeling uncertain about the overall impact of crypto6 on society, I asked him how “democratizing” revolutions tend to work out. He said they almost never work because a new, even more hierarchical power structure emerges on the new “decentralized” foundation.

Perhaps in this case, we should be wary of history rhyming7.

Thanks to Tushar Jain for conversations that inspired this post

  1. I applied Aggregation Theory to web3 in “Disaggregation Theory” many months ago to try to say something new about cryptoasset valuation. At the time, I suggested that in web2, internet giants were able to aggregate demand by building data moats that enabled superior user-facing experiences. And that in web3, because state is stored in a public ledger, it would be more difficult to aggregate demand because one could not build a data moat.

  2. I quite like Kyle Samani’s summary too: “Owning the end-customer relationship in an internet-based value chain affords the company that owns the customer relationship power over its modularized and commoditized suppliers.”

  3. Very few VCs will invest in startups that rely on an aggregator to function. The canonical example is social gaming, where an entire industry was basically wiped out when Facebook took away a single feature.

  4. “Know your customer” identity verification

  5. Chris Dixon’s now famous “Why Decentralization Matters” is mostly about this dynamic whereby the platform (aggregator) inevitably has to turn against its users and third-party developers to better monetize. He predicted that “decentralization” would solve this problem.

  6. I use this here as shorthand for the overall effort to tear down legacy institutions and replace them with “decentralized” systems.

  7. To be clear, I am not condemning fiatcoins or making moral judgments of fiatcoin issuers. As far as I can tell, the issuers are well-intentioned and pursuing a great business opportunity that–by the way–helps crypto adoption in the short term. I am simply describing the incentives as I see them and starting a discussion around the potential risks of the equilibrium state where an aggregator emerges.