Flex and Joy Discuss: Monetary Policy, Evolution of Stablecoins, and the Development Path of HOPE

Author: Flex, Joy

On March 29, the distributed stablecoin project HOPE held its first Chinese AMA. Host Joy, a partner at LD Capital, and speaker Flex, the founder of Hope, discussed the development history of stablecoins, the current macroeconomic situation, and the impact of regulatory changes in various regions on stablecoins, particularly the future development of HOPE.

Here is a highlight of the AMA.

Joy: From the perspective of the Federal Reserve, cryptocurrencies are positioned between gold and growth stocks.

Joy: I will share some insights based on macro-level information and recent events, and make predictions about future market trends.

Recently, several significant events have occurred, such as the collapse of SVB and the clearing of risks from Credit List, as well as the fallout from SVB and the clearing of risks from Space. These events have affected market funding risks to some extent. Silicon Valley Bank may influence the pace of liquidity easing in the U.S. due to the significant expansion of bank liabilities and the substantial rise in financial asset prices, which actually pose considerable risks and hidden dangers. As interest rate hikes deepen, if high-interest conditions persist, risks in the financial market will continue to erupt. However, our previous analysis suggested that the risks associated with SVB and its related institutions are not significant because their customer structure is relatively stable, and their risks are not contagious.

Against the backdrop of continuous failures of financial institutions, there is significant pressure for interest rate hikes in the U.S. Since October last year, we have predicted that this year’s rate hikes may remain around 5 percentage points. There is another rate hike expected in May, and the focus of the hikes may become apparent. Recently, we have seen continuous trading of expectations for increases in June. The volatility of risk assets, along with demand for safe-haven assets and a clustering demand for core assets, has made gold, high-tech stocks, and other emerging assets the focus of the market. As banks fail, people realize that cash assets are not absolutely stable. From the perspective of equity capital, the market will tend to hold cash, exceeding government bonds, bonds, gold, and high-tech stocks.

Currently, there are two types of risk preferences in the market, leading to a widening divergence in holding gold and high-tech stocks. Holding gold is due to its lack of implied yield, making it the safest asset during economic downturns. Conversely, holding high-tech stocks is a response to the risk explosion of cash assets, government bonds, and corporate bonds, which leads to rising bond yields and declining values. When people hold interest-bearing assets, the risk of principal loss increases. During the collapse of SVB, the attitudes of the Federal Reserve and the Treasury led people to start clustering around core assets.

In fact, the core issue is not these banks; they essentially do not have particularly difficult-to-rescue assets. The long-term U.S. Treasury bonds held by these banks are very sensitive to interest rate changes; once rates rise slightly, their values will plummet. From a technical perspective, most banks are already bankrupt, primarily because they classified these long-term bonds as "hold-to-maturity." The gains and losses of this classification do not directly affect the bank's balance sheet and audit reports, so technically, these banks have not gone bankrupt. For small banks, the problem lies in their exposure to bank run risks, forcing them to liquidate long-held U.S. Treasuries. However, when long-term U.S. Treasuries are liquidated, their losses are realized, which is the crux of the issue.

This issue is essentially a U.S. Treasury problem. To resolve it, the Federal Reserve can intervene. It can directly purchase these U.S. Treasuries or accept them as full collateral and then provide funding to the banks. Therefore, according to Professor Lou, this problem is not difficult to solve. Additionally, this provides a good excuse for the Federal Reserve to restart a zero-interest-rate policy. The Federal Reserve's policy cycle has always been four years: tightening for one year and easing for three years, which has continued for nearly fifteen years. Since 2008, the tightening phase of this cycle has ended. Therefore, the next phase should be one of easing by the Federal Reserve.

From the Federal Reserve's perspective, we position cryptocurrencies between gold and growth stocks.

This largely depends on the characteristics of the tokens. Bitcoin (BTC) essentially has no implied yield; although it has functionalities like the Lightning Network and DeFi, participation is very low. Only a few Bitcoin holders engage in activities like the Lightning Network, staking, NFTs, and farming. Therefore, we assume BTC has no implied yield, making it more similar to gold. In contrast, Ethereum, with the implementation of the Shanghai upgrade, currently has an annualized yield of over 5%, making it more akin to high-dividend, high-return stocks. Thus, we classify it closer to the growth stock end.

Bitcoin is similar to gold, while Ethereum is similar to growth stocks or tech stocks.

Flex: HOPE aims to be the on-chain Alipay connecting DeFi, CeFi, and TradFi.

Flex: Last year, after issues arose with PayPal, I was called back by shareholders and creditors to see if a restructuring could resolve the problem. However, the risk contagion in the market had not stopped, from Luna to FTX, then to BlockFi, Three Arrows, and PayPal, further spreading to affect Genesis—the largest lender in the industry. Unlike traditional markets, crypto has no central bank, and this contagion cannot be stopped; there will be no coordinated intervention from the Federal Reserve, FDIC, or Treasury.

Crypto does not have a final lender, and Genesis played a small lending role; when it had no one to save it, it essentially ended. In light of this situation, we and several large creditors have been brainstorming solutions. At that time, I recalled what I wanted to do in 2019—a distributed reserve stablecoin. It was just an idea because PayPal was particularly busy and had no energy to pursue the ideal project. After experiencing this major industry change, I wanted to move forward, which led to the creation of HOPE.

HOPE initially aimed to be a native stablecoin. However, as the market gradually developed, we identified some issues. At first, we wanted HOPE to serve as a new margin and connect to various centralized platforms. But then FTX encountered problems, and the reserves backing USDC also faced issues, leading to a decline in trust in these platforms.

Thus, although we initially aimed to solve the PayPal problem, we later realized that this project could be much larger. It is more transparent and public than PayPal's business model and is a pure DeFi project. Its goals are similar to most DeFi projects, providing a financial service endpoint that offers open, transparent, and frictionless financial services, moving away from the past system controlled by intermediaries.

However, during our project development, we increasingly noticed a macro trend: the intensifying conflict between China and the U.S. Starting with the balloon resolution, followed by later drafts involving China, the U.S. House of Representatives voted with a rare zero opposition result. Later, a Taiwan draft emerged.

This series of changes indicates that the conflict between China and the U.S. is escalating. In this process, new phenomena may arise. For example, China needs to de-dollarize, gradually removing the dollar from its settlement processes. However, the internationalization of the renminbi is a challenging task that has been difficult to advance for years. This is Plan A, which requires a long time.

China needs to de-dollarize.

At this point, there is also a Plan B, which involves using non-dollar international trade currencies, such as the pound, yen, Singapore dollar, and Hong Kong dollar. However, the Russia-Ukraine war has provided a precedent; the U.S. froze and confiscated many Russians' overseas assets. Therefore, although Plan B is feasible, people do not fully trust it. This leads to Plan C, which we refer to as a crypto payment gateway, directly resulting in the rapid opening of Hong Kong.

Hong Kong's crypto opening has two goals. First, as Plan C, it aims to become a port for China's foreign trade. As a bridge connecting China and the world, Hong Kong will continue to play an important role in the future. On the other hand, we need to reassure everyone to invest in Hong Kong, hoping that more overseas Chinese can return to Hong Kong to start businesses, whether in the crypto field or non-crypto sectors.

Thus, from these three perspectives, the crypto opportunities in Hong Kong are substantial. For HOPE, it also aligns with this new trend. In the future, amid changes in international geopolitical dynamics, it will facilitate foreign trade in the region. If we view Plan A as a flagship, then Plan B is a destroyer, while cryptocurrencies play the role of a pirate ship.

In reality, this is a long-term vision, hoping to become an international trade settlement currency in the future. In the short term, it remains a project similar to a BTC/ETH tracking token. We aim to develop it into a very good collateral—one with high liquidity and collateral for the interest rate market. Therefore, we will use hope swap to realize its liquidity market and hope lend to establish the currency market, thus forming a highly liquid exchange rate market and interest rate market. Only in this way can it serve as excellent collateral and be applied in various transactions.

So, our long-term goal is to become an international settlement currency between 2026 and 2029, while the short-term goal is to build it into a high-quality collateral between 2023 and 2025. This is what I refer to as collateral that spans DeFi, CeFi, and TradFi. DeFi, which is protocol-based, is coded, meaning it cannot be easily changed, so we say DeFi is relatively secure. However, it also has its own issues, namely a lack of flexibility.

We hope to push it towards CeFi, at which point we will use a protocol called Connect, a lightweight on-chain protocol that you can think of as on-chain Alipay. Just like when using Alipay in 2006, the main goal was to ensure that your money remained in Alipay while the seller shipped the goods. Once the goods were received, you would confirm, and only then would the money transfer from Alipay to the seller—this is the escrow function. We hope that the lightweight settlement system will eventually connect to DeFi, first linking DeFi and CeFi.

As for TradFi, it is still dominated by the dollar, with the U.S. defining who the good and bad actors are. But why should the U.S. define these things? Why not a protocol, or the people themselves?

We hope that HOPE can become a universal collateral across these three domains. Through this planning, we hope that HOPE can gradually achieve its long-term goal of providing a new option for international trade settlement while also offering high-quality collateral in the short term to meet the needs of various sectors and promote the development of the entire cryptocurrency and financial ecosystem.

Joy and Flex review the history of stablecoin development.

Joy: The first batch of stablecoins should have been issued in 2014; they were designed as asset-backed stablecoins for BTC, but at that time, regulatory oversight in various countries and regions had not reached today's level. However, with gradual regulatory changes, it has developed into today's landscape.

Flex: USDT has become a middleware. The development reasons for USDT, USDC, and others are varied, including backing entities, yield capabilities, and security.

Joy: Different types of stablecoins like USDT and USDC have their pros and cons in the market, and they may develop into a decentralized management model in the future. The political environment in the U.S. has influenced emerging companies like Coinbase.

Flex: The rise and fall of Terra Luna are closely related to factors like risk-free arbitrage in the market and capital flow. The HOPE project responds to market fluctuations and attacks through prior reserves.

Joy: One reason for USDT's good development in recent years is its more diversified asset backing, including commercial paper, corporate bonds, and money market funds. In contrast, USDC's backing is relatively singular, with 74% in cash and cash equivalents and 26% in short-term government bonds. From this perspective, USDT has stronger yield capabilities and is also safer.

Flex: The development process of USDT:

1) Initially, redeeming USDT was relatively difficult.

2) Bitfinex supported USDT, thus forming a certain market.

3) USDC is institutionalized in the U.S., launched by Coinbase and Circle, compliant and legal, making U.S. institutions more willing to use it.

4) BUSD is a product of the collaboration between Binance and Paxos, and Binance has held a series of events targeting BUSD.

Joy: We believe that all public chains, Layer 1, Layer 2, and even Layer 3 will be regarded as decentralized management in Web 3.0. Currently, the CFTC and SEC are competing for regulatory authority.

Flex: Coinbase is not actually aligned with the interests of the U.S. establishment; the establishment's interests lie with Nasdaq, the New York Stock Exchange, and banks. Therefore, the establishment may abolish these emerging cryptocurrency exchanges in the future, as determined by the U.S. political environment.

Joy: The collapse of FTX was influenced by the aftermath of Luna; as a representative of over-collateralized stablecoins, the rise and fall of Terra and Luna cannot serve as a standard for judging the viability of over-collateralized stablecoins.

Flex: Luna's ecosystem and Swap were well executed, and the mechanism was good; innovations like Base Rate were also viable. The rapid rise and fall of Terra were due to the market boom in 2021, which brought many opportunities, especially risk-free arbitrage in the crypto market, with annual yields reaching 40% to 50%. However, after May 19, this opportunity disappeared. Nevertheless, due to high friction in capital inflow and outflow, funds were still reluctant to exit. With nowhere to go, funds flowed into Luna and Terra, scaling from less than $50 million to $100 million in less than a year.

However, with low market enthusiasm and a large influx of funds, the pressure became too great, leading to reserves in BTC, using Luna to mint Terra, and then using Terra to purchase BTC. Although the purchase of BTC with Luna triggered a small bull market, when Luna came under attack, it caused significant market volatility. At that time, FTX was the largest liquidity provider in the market, but its algorithm did not account for the possibility of the market going to zero, leading to its eventual collapse.

To respond to various attacks, HOPE plans to first build reserves, then develop algorithms.

Joy: I summarize that algorithmic stablecoins face an impossible triangle, with three corners representing stability, decentralization, and capital efficiency; these three points cannot coexist.

Common stablecoins can be broadly categorized into four routes: 1) Resource-backed like USDT, USDC; 2) Over-collateralized like MakerDAO; 3) Algorithmic stablecoins like Terra Luna, USBN on Venus; 4) Completely decentralized stablecoins like Reflexivity, Liquity, etc. These stablecoins face challenges in stability, decentralization, and capital efficiency, and it is difficult for these three to coexist.

HOPE, at this point, chooses to use assets as underlying collateral, which cannot balance decentralization, but its distributed storage and capital efficiency perform well. The impossible triangle will change with the fluctuations in market funding risks, and there may be many developmental possibilities in the future. HOPE will gradually launch functions like Lend and Swap, which is an iteration and further development of the product.

How does HOPE solve the "impossible triangle" of stablecoins?

Flex: To avoid the dilemma of the impossible triangle, HOPE uses time to exchange for space, sacrificing current capital efficiency for future capital efficiency. The next phase is expected to be a loosening phase, with both monetary and fiscal policies easing. Next year may be a turning point, with both monetary and fiscal policies easing, which will benefit the rise of emerging assets like BTC and ETH.

During the bear market, we will first build reserves, and during the bull market, we will have significant room for easing. Afterward, we can convert BTC and ETH reserves into stable reserves, including fifth-generation stablecoins like CurveUSD and AaveUSD. These stablecoins may become the reserve objects for HOPE in the future.

Joy: Currently, the debt structure presents a triangular debt form, with A embedded in B, B embedded in C, and C embedded in A, with the core and essence lying in the price of the underlying assets. As long as the price of the underlying assets rebounds, the entire price can rise. Currently, banks face significant challenges in terms of friendliness, difficulty in capital inflow and outflow, and the application scenarios of stablecoins; this is both an opportunity and a challenge for Flex and HOPE. Hong Kong's compliance measures in custody, trading, asset management, and stablecoins will expand market size and lower the barriers to entry.

Flex: Hong Kong has two major advantages: first, stricter regulation of speculative behavior; second, stronger regulatory capacity for stablecoins.

Hong Kong will have strong regulatory authority and development space in the field of stablecoins in the future, and many excellent stablecoins may choose Hong Kong because the HKMA and SFC know how to regulate.

Joy: The regulatory environment in Hong Kong, combined with other business forms, will facilitate the rapid development of stablecoins. For example, many banks in Hong Kong are more friendly towards stablecoins than banks in regions like Singapore. Overall, the capital inflow and outflow channels in Asia are smoother than in Europe and the U.S. With the theme of the East rising and the West falling, the development prospects of HOPE's stablecoin are promising. This is akin to Wang Huiwen in the Web3 field, transitioning from Meituan to AI, entering a larger and more certain track, where the probability of success is very high.

Q&A: How does HOPE plan to custody BTC? How will it achieve protocol reserves?

Flex: Essentially, we are a DeFi project, but we have made some compromises for two reasons. First, to develop the incremental market, we need to make it easier for funds from Hong Kong, the Middle East, and Europe to enter the market. Therefore, in the early years, we chose distributed custody, initially selecting Coinbase because it performs best in custody support, user experience, and compliance.

Second, we need to address the BTC contract issue. Although HOPE's goal is decentralization, we are actually using centralized custody. Coinbase provides independent accounts, making our approach similar to how Bank of China, Standard Chartered, and HSBC operate with the HKMA. These banks can reserve U.S. dollars with the HKMA and then issue Hong Kong dollars with their own logos. In HOPE, we are akin to the HKMA, acting as the issuer of the stablecoin.

We will not directly face customers but will work through distributors. When customers deposit BTC into a designated address at Coinbase, we will confirm their reserves and allow them to mint the corresponding amount of HOPE in the HOPE protocol. When customers want to withdraw their reserves, they need to first burn $HOPE and then initiate a withdrawal request, which will be approved by Power Oracle and then by Coinbase for withdrawal.

Although there are still centralized risks, Coinbase is one of the institutions with the lowest risks, and most institutions are still willing to deposit coins. Initially, HOPE uses Coinbase as reserves, but the long-term goal is for compliant funds and institutions in various regions to become our distributors and issue HOPE. Even less developed public chains can issue HOPE, allowing it to operate in their DeFi.

HOPE's initial approach is to use Coinbase for reserve preparation, but the long-term goal is to achieve protocol reserves. Currently, HOPE operates similarly to the dollar: first reserves, then investments. Our essential goal is the same, which is to first reserve HOPE, and when the reserve assets significantly exceed the issued HOPE, we can over-issue HOPE. The over-issued HOPE will return to the community, with the team collecting a 30% fee. In practice, the newly issued HOPE can operate in various DeFi protocols, generating more value. At this point, HOPE reserves become a means of market promotion.

Q&A: What is the minting process for HOPE? How will it solve the price anchoring issue?

Flex: Regarding the rules and design of HOPE, it is true that the project may face challenges in tracking prices in the early stages. To achieve decentralization while ensuring security, HOPE adopts a dealer model, with dedicated distributors handling wholesale and market expansion. At the same time, individuals can directly purchase HOPE on decentralized trading platforms using various coins.

Regarding the price tracking issue, HOPE's initial value is 0.5; theoretically, when the collateral assets double in value, HOPE's price should track to 1. However, practical operations may encounter some challenges. For example, DAI initially had insufficient use cases, leading to its price being consistently below 1. When ETH plummeted, only those needing to buy back DAI would push its price back to 1.

Similarly, HOPE may also face difficulties in price tracking in the early stages of the project. Due to a lack of smooth redemption processes, it may require finding trustees, and the friction and time costs in between may lead to price tracking deviations. However, as the project develops and use cases expand, this situation should gradually improve.

For the HOPE project, the key is to gradually achieve decentralization and enrich use cases while ensuring safety and compliance, thereby enhancing the project's practicality and value. Over time, the project team can continuously optimize and improve product design to better address these challenges.

The development of the HOPE project can be divided into three phases:

Phase One: As collateral for derivatives trading on centralized exchanges. Customers will place HOPE on-chain, and through a mechanism similar to Maker, once HOPE is recognized, they can mint USD. This USD has designated uses and can be used for trading on brokerage accounts at exchanges.

Phase Two: Decentralized finance. Customers will place coins on-chain to generate USD, and HOPE will grant credit to fund managers. After fund managers complete trades on centralized exchanges, profits will return on-chain, realizing a settlement solution.

Phase Three: Connecting DeFi, CeFi, and TradFi. Collaborating with global brokerages to enable USB generated in CDPs to directly purchase synthetic assets, stocks, etc., allowing for trading stocks without capital outflow.

HOPE's initial goal is to serve as collateral, but its most important future function will be payment and global settlement. The project's vision is not only to use HOPE for generating profits but also to ensure its practicality. Open and transparent lightweight settlement will reduce the likelihood of malicious behavior.

The HOPE project is similar to Alipay, first developing financial products and then payment functionalities. The reason for prioritizing financial products is that initially, HOPE is not a stablecoin and needs to ensure liquidity, so it first focuses on collateral functions. In the future, when HOPE becomes a stablecoin, the escrow function will become more important.

The project will make decisions about custodians in a decentralized manner, with the establishment of a DAO as a core goal.

Hope and brightness are the two major goals of the HOPE project.

The first is to instill hope in young people, building a better community of their own. The second goal is to work openly and transparently, providing people with a fair, open, and transparent platform.

Q&A: How should we understand the reserve exchange in the third phase of HOPE? Why choose BTC and ETH now if we plan to exchange in the future?

Flex: In the development of HOPE, the third phase will involve reserve exchanges. In the initial phase, HOPE will use BTC and ETH as reserves, which indeed has the characteristics of cryptocurrencies. However, in the later stages, reserves will shift towards decentralized stablecoins. This transition does not mean losing self-characteristics but is based on the following reasons:

1) Using time to exchange for space: To quickly make HOPE a large-scale stablecoin, the project needs to leverage the upward process of BTC and ETH. Additionally, using BTC and ETH as reserves can bring tremendous value to LT, making it a perpetual call option.

2) Future stablecoin market: The goal of the reserve exchange is not the existing stablecoins but to focus on excellent stablecoins in the market two years from now, such as CurveUSD and AaveUSD. These stablecoins have unique natural advantages; for example, Curve can quickly convert other stablecoins. More diversified reserves, including non-dollar assets like U.S. Treasury bonds, Hong Kong government bonds, and Singapore government bonds, can also serve as reserves. This choice relates to improving capital efficiency by reducing over-reserves to enhance reserve efficiency.

In the longer term, when the HOPE protocol has good credit, there may be more application scenarios. For example, as a system party, Curve's on-chain debt may be directly purchased and reserved by HOPE, making HOPE an important component of a certain pool. This will gradually evolve HOPE into an algorithmic stablecoin.

The HOPE project also plans to launch various compliant funds globally, with well-known fund institutions issuing HOPE stablecoins. This will attract fiat investments into the HOPE ecosystem, generating returns that can flow back to fiat for institutions. Such a development strategy will help the HOPE project succeed globally.