Co-Founder CEO @ Pareto Network, Founder & BD @ Blockology Advisory Firm (Blockchain Development Co)
(fig. 1 - Patent number 10121126 is readable here)
“A hedge fund system that removes volatility from crypto accounts” — INC. Magazine
“Helps Bitcoin not seem so volatile.” — Digital Trends Live
“The thing to finally put skeptical minds to rest about the viability of crypto assets” — The Block Talk
The “Stablecoin Patent” I filed in 2014 and received in 2018 has been written about in a variety of publications and mentioned in several interviews and podcasts. As some aspects of it are esoteric, this will help breakdown what its purpose is and how it promotes the progress of science and useful arts.
This patent describes a two-account system that balances and adjusts the value of both/all the accounts so that the total value of both accounts remains the same. You can use the word portfolio to describe the collection of assets and accounts, but extend it outside of the investment context into a consumer retail application after the advances in infrastructure are put into place.
Colloquially, the term “stablecoin” was not in use when this patent was drafted and filed in 2014. Similarly, in practice, the stablecoins that reached the market during that decade do not implement my strategy for providing stable value to users of crypto assets. Disinflationary and deflationary digital assets align the incentives for market participants to make them scarce and valuable, by improving their utility and scarcity. Stablecoins that are separate digital assets do not accomplish this and dilute the capital reaching the native digital assets, eventually hampering the security model and confidence in the digital asset’s foundational ledger (the blockchain).
For example, when $100 is used to purchase Bitcoin it makes bitcoin slightly more scarce, whereas using $100 being to purchase Tether simply creates more Tether. Tether payments and ownership operate on the same network as bitcoin payments and ownership (the bitcoin blockchain), but bitcoin is not made more scarce when native bitcoin payments and ownership are not being used.
(fig. 2 - Live view of existing value being traded for bitcoin, by currency. Source: fiatleak.com)
The concept behind Tether is that it is “tethered” to the value it was converted from. $100 in USD equals $100 of Tether. Tether ownership allows users to participate in the digital asset economy in a way that has been incompatible with fiat currencies while retaining the predictable value of fiat currencies. To accomplish this, Tether is operated by a group of large companies and an army of lawyers, who spend unfathomable resources maintaining banking relationships, fielding state-level legal challenges, operational security, and maintaining confidence in the system to support the Tether asset’s value and promises of convertibility.
The invention is based on the observation that this level of infrastructure is not necessary, and that parallel meta assets dilute capital, utility and price discovery of the native digital assets such as Bitcoin.
(fig. 3 - Comparisons. MakerDao DAI collateralizes digital assets, some are native, requires community votes to increase issuance & self perpetuate.)
To understand the utility and differentiating factors of this stablecoin patent, there are a few key components to understand:
This patent builds upon these pre-existing tools and combines them to add utility to the crypto and digital asset market participants.
Spot & Derivatives
Spot assets are the real or physical version of the asset. They can also be contractual claims for the asset as long as they perfectly track the prices of the asset. So owning a piece of gold, or a certificate that says you own gold would be the spot asset.
Derivatives are merely assets whose price is “derived” from a spot asset, and they have a different independent price from the spot asset and the pricing mechanisms occur for different reasons. For example, a gold future has a different price than gold, and a gold option has a wildly different price than the gold future or spot gold. The word spot can be interchanged with “underlying” when the context is a derivative, as you need to know what “underlies” a derivative contract. Underlying assets do not have to be spot assets as they can be other derivative contracts. For example, a gold futures contract is a derivative of spot gold, the underlying being physical gold. A gold futures options contract is a derivative as well, with the underlying being a gold futures contract.
The same concept can apply to any asset. Such as bitcoin. In the coming years, more digital assets will have more derivatives, operating in standardized, predictable, regulated environments. In the United States, it is impossible to operate derivatives outside of regulated environments, and the United States attracts the highest degree of market confidence and capital. It is therefore important to build the infrastructure for digital assets derivatives in the US, as exchanges operating in other countries have already handicapped the capital and liquidity they can attract.
Although this explanation relies on incumbent financial institutions to host infrastructure, the patent predicts the rise of decentralized finance which is now known as “DeFi”, which allows for autonomous robust exchange and contract execution without the permission or predilection of a regulator and the financial institutions whom they license.
Delta hedging mitigates risk in a portfolio, where the rise of the spot asset offsets the fall in the derivative asset, and vice versa. The granularity in the transaction sizes of digital and crypto assets allows for more effective delta hedging.
(fig. 4 - Delta Hedging illustration from https://www.investopedia.com/terms/d/deltahedging.asp)
This form of delta hedging has the goal of staying delta neutral, with the positive delta spot asset appreciating on the rise of its value, and the negative delta derivative appreciating on the fall of the spot asset’s value.
This refers to a single portfolio of assets that is capable of managing the risk and accounting of multiple types of assets. Specifically where the margin and collateral requirements are lower because different kinds of collateral are taken into account. Cross margining is an embellishment that has the possibility of increasing the practicality of implementing this system, but not a requirement.
In this case, margining systems need to monitor the spot and the derivatives positions. The current landscape of portfolios are built exclusively for active investors, and typically for a single market. For example, a portfolio for the stock market would only have stocks, a portfolio for the futures market would only have futures, a portfolio for real estate would only have the value of homes in them. Cross margining has been in the purview of investment bankers, but the concept can be extended outside of the institutional investment world, leapfrogging exposure to the retail investor, providing utility to the consumer who now operates between parallel global economies and requires predictable stable value of their digital assets.
For example, if a mortgage application required 20% collateral against the value of the home, in a cross-margining system the mortgage application would look at the applicant’s stock portfolio, evaluate the risk of its value changing, and allow that as collateral therefore not requiring the applicant to liquidate.
Banks, brokers, digital wallets, and exchanges have to extend the ability to own the spot digital assets — such as real bitcoin — alongside ownership of the futures and options.
The advantage of digital assets, compared to physical assets, is the infinite divisibility. So even though Bitcoin is deflationary properties, forcing it to rise in value to high extremes, a smaller and smaller fraction of a bitcoin can be used to purchase goods and services which retain a fixed price in their relative local economy.
(fig. 5 - Diagram from patent)
These components working together allow for the financial inclusion that is promised by the digital asset blockchain technology (cryptocurrency) while exempting consumers from volatility. All values can successfully leak from the state-run economic system into the decentralized, permissionless, global digital asset economy. Thereby accelerating the price discovery and repricing of native digital assets like Bitcoin.
The current infrastructure to support this simply requires the existence of standardized and regulated futures and options contracts.
At the beginning of this new decade, only Bitcoin has standardized regulated futures and futures options contracts, setting its available infrastructure far ahead of any competing digital currency. Competition in this arena has promoted cash-settled bitcoin futures, cash-settled bitcoin futures options, somewhat physically-settled bitcoin futures, and somewhat physically-settled bitcoin futures options. Current contract sizes are for 1 or 5 bitcoin, which still results in derivatives contracts to expensive for expanded utility.
More competition can bring about smaller contracts, such as how the S&P 500 has both the E-mini futures contract, and the micro E-mini futures contract.
Better price discovery in bitcoin can mean lower margin requirements, allowing for much less capital to be put up to hold any futures contract, even futures that represent fractional amounts of bitcoin as the underlying.
A consumer’s application can show a stable value, and the stable value can be spent like a meta asset similar to how Tether and other stablecoin balances are represented, but there would be no meta asset diluting capital away from the native digital assets powering the whole system.
(fig. 6 - Square’s “Cash” mobile app, featuring its Bitcoin custodial features. For illustrative purposes.)
Hiding the deflationary properties of Bitcoin allows Bitcoin to function as a currency for consumers, and as a currency in the economy for investment. The economy is not built around deflationary assets, and prevailing schools of economics only function when the native asset (fiat currency) is inflationary, the idea being to force the entire market to continually search for returns that exceed the rate of inflation. Hedged digital assets functioning as surrogates and mere visual representations of stable fiat currencies will expand their utility as currency. This nullifies all arguments against a cryptocurrency’s ability to be a currency, pushing the goalpost much further towards even higher fictional standards towards a perfect transmutable, programmable asset class.
You can read the plain text of this stablecoin patent here. It is not specifically a “blockchain patent” because the patent envisions other kinds of distributed ledger technologies (DLT) existing. It does not specifically mention “smart contracts”, but envisions the auto-executing covenants of an agreement being able to power global exchange and universe-wide state machine. It is not specifically a “DeFi” (decentralized finance) patent because the term did not exist. It does not specifically mention “oracles” because that also was not in the collective consciousness as an agreed-upon term, but the automatic portfolio rebalancing relies upon external pricing data to be evaluated for transactions to occur.
There are continuation patent(s) filed for US 10,121,126 B2 to further promote the progress of science and useful arts, and align with the direction that the market has formed.