From Moneyness, January 22:
How are we consumers to know whether the dollars that financial institutions provide us aren't fraudulent dollars? On what basis can we assume that the funds we hold at PayPal, for instance, or in Cash App, are "good money"?
It's an age-old problem. If you were alive in 1889 and someone offered to pay you with a $10 note from Banque d'Hochelaga (see below), a privately-owned Montreal-based bank, how could you know the issuer wasn't a fraud and that it had enough assets on hand to always redeem notes with gold and/or silver?The question of fabricating trust in dollars also applies to today's rapidly growing stablecoin sector. Stablecoins are dollars issued on public blockchains like Ethereum or Tron. Tether has an astonishing $24 billion in U.S. dollar stablecoins in circulation, up from just $1 billion three years ago. Competitor USDC has issued about $5 billion in stablecoins, up from $0.5 billion at the beginning of 2020. On what basis can a potential user trust these stablecoin dollars? How do we know that the $500 in Tethers or USDC that someone wants to send us won't melt to $0 a few days from now?
Consumers use simple rules of thumb to differentiate between good dollars and bad ones. We'll call them:- everyone's using it
- Warren Buffett owns some
- JP Morgan trusts them
- show us the money
- big brother is watching
The first rule of thumb is the everyone's using it approach. If all your friends and family are using Tethers or PayPal or Banque d’Hochelaga notes, then it's probably safe for you to do so too.
There is plenty of wisdom in everyone's using it. If there are thousands of Tether users, then it's likely that at least a few of the more diligent ones have already dug deeper to ascertain the issuer isn't fraudulent, and so we can all piggy-back off of their work. This saves us the hassle of doing our own audit.
Everyone's using it is by no means a fail-proof method of determining the validity of a dollar. If no single user has done sufficient due diligence, then everyone is operating blindly. That's how Bernie Madoff managed to keep things going for so long.
The second rule that consumers use to validate dollars is the Warren Buffett owns some approach. Similar to everyone's using it, the Warren Buffett owns some approach piggy-backs off the work of others. But rather than relying on other users, it free-rides off of the expertise of sophisticated investors....
....MUCH MORE
