Since the publication of Can A Stablecoin Be Collateralized By A Fully Decentralized, Physical Asset? in Cryptoeconomic Systems Volume 2, Issue 1, the concept of an E-Stablecoin, proposed by the authors, has been widely discussed. Here, article co-author Maxwell Murialdo addresses some popular misconceptions about E-Stablecoin. — CES Editors
E-Stablecoin stands for “Electricity Stablecoin,” the first-ever theoretical class of stablecoins that are both fully decentralized and fully collateralized by a physical asset. Whereas other stablecoins are pegged to external assets like the US dollar (Tether) or one gram of gold (Digix), an E-Stablecoin token is pegged to the price of one kilowatt-hour of electricity. However, the way in which the E-Stablecoin concept achieves this price peg is unlike any other stablecoin to date. E-Stablecoin actually uses thermodynamics to effectively transfer electricity in a peer-to-peer manner across the blockchain.
Stablecoins are cryptocurrency tokens that are designed to remain stable in price (relative to an external asset). Currently available stablecoins suffer from a dilemma: they can either be collateralized by something external (e.g., USD or gold) or they can be fully decentralized, but not both. This occurs because the assets that back up each stablecoin token need to be secured and managed by a centralized asset custodian, like a company, bank, or nation. For example, if a stablecoin token is collateralized by physical gold, some centralized custodian has to maintain the vaults where the gold is stored and distribute the gold in exchange for stablecoin tokens. This level of required trust and centralization is antithetical to the ethos of decentralized cryptocurrencies.
The alternative is to have a stablecoin that is not collateralized, but instead uses algorithms to attempt to keep the token price stable (known as algorithmic stablecoins). However, because algorithmic stablecoins don’t have one-to-one collateral in reserve, they are at risk of catastrophic price collapse, as occurred to TerraUSD in May 2022.
An ideal stablecoin would be both fully collateralized and fully decentralized at the same time, leading to improved price stability and requiring no trust in centralized custodians. The first question we set out to answer in our research was whether it was even theoretically possible to achieve both of these features simultaneously. We found that the answer is, surprisingly, yes. Our research therefore serves as a theoretical proof of concept. Secondly, we wanted to study how thermodynamics could advance future applications of the blockchain. Finally, the theoretical concept of E-Stablecoin helps to illuminate key assumptions in how today’s cryptocurrencies operate and derive value.
Bitcoin is already intimately connected to the consumption of electricity through its proof-of-work mining process. Likewise, the crypto project Meter.io already claims to have a stablecoin that is “pegged” to the price of electricity. Meter.io is set up to ensure that each token minted requires the consumption of 10 kWh of electricity.
However, E-Stablecoin is different in one very crucial way. Bitcoin and Meter.io base their security on the consumption of electricity and may even claim to be “pegged” to the price of electricity, but neither is collateralized by electricity. That is, those projects consume electricity on the front end but cannot generate that electricity on the back end. The electricity is consumed and then gone. Conversely, with E-Stablecoin, the quantity of electricity that is put into the system is not lost and can later be extracted and used. This means that each E-Stablecoin token is not only associated with the consumption of approximately one kWh of electricity, it is also redeemable for approximately one kWh of usable electricity. In this sense, it is “collateralized” by electricity.
Imagine, for instance, that someone in Brazil has solar cells on their roof and generates more electrical energy than they consume. They could choose to use their excess electricity to mint E-Stablecoin tokens. They might then sell (or otherwise transact with) their tokens. The tokens might end up in the hands of someone in Germany, who could then “burn” the tokens to receive electrical energy (e.g., to run their lights).
However, this doesn’t mean that two kWh of electricity are generated. Only one kWh of electricity is associated with each E-Stablecoin token. The energy is effectively transferred from Brazil to Germany.
E-Stablecoin doesn’t transfer this energy directly. It only transfers a digital number consisting of zeros and ones. This transfer of information allows the party in Germany to pull heat directly out of the ground and convert it into work, which can take the form of electricity.
As counterintuitive as it may seem, E-Stablecoin does not require violating or rewriting the laws of physics—the first and second laws of thermodynamics, for example, are preserved. As a first point of clarification, the paper makes use of the term “free energy.” This term has led to a lot of confusion online. In science, “free energy” is a technical term that denotes the portion of the total energy that is available to perform work at a constant temperature and pressure. The term “free energy” is in no sense intended to suggest that energy can be obtained without cost or consequence. The E-Stablecoin concept is a way to transfer energy that has already been generated in a traditional fashion (e.g., solar cells), not a way to generate energy. There is no free lunch in E-Stablecoin.
The first law of thermodynamics pertains to the total energy in a closed system. However, not all of the energy in the closed system can be used to perform work. For example, the heat energy within a single temperature bath in isolation cannot generally be extracted to perform work, based on the second law of thermodynamics. This is why, in general circumstances, you can’t simply pull heat out of the ground and use it to run your lights. However, E-Stablecoin exploits a loophole—entropy can be transferred as information, not just by a direct heat transfer. In this way Brazil and Germany can be linked together as a single thermodynamic system through a data transfer channel. Using this link, heat can be pulled directly out of the ground in Germany and used to perform work in Germany (i.e., electricity) while leaving the counterparty in Brazil to deal with the entropic consequences (i.e., erasure of “waste data”). For this reason, neither the first nor the second laws of thermodynamics are violated. No energy content is actually transferred out of Germany, and the entropy of a closed system does not decrease.
The primary goal of E-Stablecoin is to conceptualize a stablecoin that is both collateralized by a physical asset and fully decentralized. This is possible with E-Stablecoin because no shared energy transmission infrastructure is required (only information is transmitted). Therefore, E-Stablecoin does not require a conventional electrical grid or anything like it. In contrast, any alternate system requiring shared infrastructure, such as an electrical grid, poses many questions that point towards centralized custodians or authorities, in opposition to decentralization. For example, who would own and maintain the electrical grid? Who would police the electrical grid against sabotage or freeloaders attempting to illegally siphon off electricity? Who would control where user nodes could be added to the grid, and how would they measure the amount of electricity that each user contributes or consumes from the grid? Would this be done with a physical meter? If these meters are decentralized and unsupervised, how could we ensure that the meters are not physically compromised? These and other questions point towards the need for some centralized custodian and/or authority to regulate and control any system involving shared energy infrastructure. To reiterate, centralized custodians and authorities are very much contrary to the ethos of E-Stablecoin. Similar problems would also apply to a system that transmits energy directly via concentrated laser pulses or microwaves.
E-Stablecoin, on the other hand, does not transmit physical energy directly. Instead, it only transmits information, which in turn allows the anonymous parties to extract usable energy at their individual locations. The differences between transmitting energy directly and only transmitting information are massive. Information is subject to and secured by known laws of mathematics and cryptography, ensuring that the transmission of E-Stablecoin does not involve protecting, policing, regulating, or metering shared physical infrastructure. The only physical devices needed for E-Stablecoin are held individually by the decentralized users of the network, and each participant has their own incentive and responsibility to protect their own devices. While a means to transmit information is needed, this can potentially be achieved with a diversity of different shared information channels (like the internet), and there is no incentive to “steal” the transmitted data, as it is only “waste data” to begin with.
In our paper we define the “Emergent Value Hypothesis” (or EVH for short) as the hypothesis that “an asset can stably hold value purely as a result of a sufficient number of people believing that it holds value.” This hypothesis is key to understanding the importance of E-Stablecoin.
First, let’s define assets, and what distinguishes them from currencies. In our parlance, a currency is used broadly and with great frequency for a number of everyday real-world purchases, such as cars, clothes, services, cups of coffee, and everything in between. The ubiquity of buyers and sellers directly using, recognizing, and accepting the currency is essential, as this affords the currency strong protections through the direct network effect. For a currency, each unique pairing (or potential pairing) between a buyer and a seller represents an additional link in the network and adding users can exponentially grow the overall number of links. Conversely, in our parlance an asset is something primarily designed to hold value over significant periods of time and is not transacted in everyday real-world purchases with great frequency or ubiquity. Assets therefore are not necessarily afforded strong protections by the direct network effect. In fact, assets don’t necessarily need broad popularity—for example, a rare metal catalyst used in obscure industrial processes could be held as an asset despite very few people knowing of its existence (i.e., a relatively small number of distinct links connecting buyers to middlemen to sellers). Thus far, Bitcoin tends to behave more like an asset than a currency by this definition.
The second subtlety of the hypothesis is that the asset must hold value stably. Here, we define stably as not fluctuating up and down wildly in price over the span of multiple decades and across millions of people from diverse cultures and backgrounds. This is the hope for Bitcoin—relative stability after a period of price discovery. Note that for the purposes of this discussion we are only interested in “exchange value,” that is, the price for which an asset is sold on the open market (without trying to define more abstract concepts like “inherent value”). The exchange value of an asset is set by the interplay of the supply of and demand for that asset. In cases like Bitcoin where the supply is held steady (or capped), demand must also be held steady in order to establish a steady price.
Finally, and most importantly, the hypothesis posits that the asset will stably hold value “purely as a result of a sufficient number of people believing that it holds value.” This is the emergent part—that there is nothing external or intrinsic holding up the value. EVH therefore implies that “an asset that is initially devoid of intrinsic value can stably amass value as it amasses adopters, brand awareness, or popularity.” This means that the power of collective belief on its own is sufficient to stably maintain the asset value. For an asset like Bitcoin, where supply is held steady, this would necessitate that the power of collective belief be able to produce and hold a steady demand. As EVH is only a hypothesis, it is not yet proven or disproven.
It is tempting to argue that all value is emergent. Collective belief certainly seems to be an important factor in establishing the prices of many assets. However, it is clear that this oversimplification cannot stand. The demand for most assets is not driven by collective belief alone—they also require some kernel of intrinsic demand to solidify and stabilize their value. Accordingly, these assets maintain value through some interplay of intrinsic demand and collective belief. We can look to a few case studies to illustrate why.
Imagine that someone has put a delicious chocolate cake in front of me. They have also informed me that the collective world has come to believe that chocolate cake has no value. This collective sentiment will not deter me from first craving the cake, then eating and enjoying the cake, and finally using those calories to energize my body.
My demand for that cake could not be fully erased simply by a general collective belief that it has no value. The cake possesses some intrinsic demand independent of any emergent value. Note that I am not talking about intrinsic value, an idea that is much too hard to define here. Instead, I am only talking about intrinsic demand, which is to say that there is some innate reason why I would want that cake independent of the beliefs of others. If I were trapped alone on a desert island, I would still want the cake, regardless of whether or not anyone was there to inform me that cake is not en vogue.
This is not to deny that branding, marketing, fashions, and beliefs can have a significant impact on how much a particular cake will sell for at the market. Certainly, collective beliefs can inflate or manipulate the price of goods. Nonetheless, what I find most interesting is the kernel of intrinsic demand that exists independently of the beliefs of others, and that kernel’s impact on stabilizing the price of assets. Throughout history, almost every stable asset, from land to oil to artwork, has been built upon a kernel of intrinsic demand. This kernel of intrinsic demand arguably plays a role in stabilizing the price of the asset by providing a reference point, a motivation to buy the dip, and perhaps even a price floor. The kernel of intrinsic demand is a key factor in stabilizing the supply/demand feedback loop that dictates price.
Does gold have intrinsic demand? Yes. Contrary to popular belief, gold is not valuable just because it is rare. It is both rare and has intrinsic demand. Most gold is not held as bullion reserve but is instead used in real-world applications. These applications include electronics, science, medicine, dentistry, and most significantly, jewelry and artwork. Moreover, it is important to recognize that gold is not used in jewelry and artwork simply because it is considered valuable. Gold has been used in jewelry and artwork by non-connected cultures across the continents for millennia because it possesses unique materials properties that make it ideally suited for jewelry and artwork. (Note that there are many other rare substances that we would not deign to wear as jewelry or bother to use in artwork because their material properties are not well suited for it.) To begin with, gold is shiny, as it does not form an oxide layer. Second, gold is extremely malleable, which makes it easily workable into jewelry or artwork. Finally, gold has a yellowish color that is rather unique among metals. Given gold’s multiple applications, gold certainly has intrinsic demand which can help to stabilize its value as an asset over the long run.
What about US dollars? I would argue that USD has pseudo-intrinsic demand that is set up and enforced by a centralized external authority. This demand takes the form of taxes.
The IRS demands that all federal US taxes be denominated in and paid in US dollars (not Bitcoin, oil, gold, etc.). Moreover, if those taxes are not paid, the government will send in the police or, if need be, the national guard to collect them. This arrangement ensures that everyone in the US has a demand for USD. At the end of each year, individuals need to have accumulated enough USD to pay their taxes or else face the threat of force. This connection between the armed forces and money is likely not a coincidence either. Historically, the advent of coined money seems to have largely coincided with the rise of professional standing armies and their salaries.
Furthermore, under our classification of “currency” vs “asset,” USD functions very much as a currency, with distinct buyers and sellers connected through a huge number of links in everyday real-world transactions, giving it strong protections by the direct network effect.
A fundamental distinction between E-Stablecoin and other decentralized stablecoins is that E-Stablecoin does not rely on the Emergent Value Hypothesis. E-Stablecoin uses smart contract algorithms to self-regulate, but is fundamentally distinct from other algorithmic stablecoins, because it is directly collateralized by a physical asset with intrinsic utility (electricity). The system is designed so that at all times the number of E-Stablecoin tokens in circulation matches the number of kilowatt-hours of electricity available for withdrawal (fees notwithstanding). This feature is not just a convenient talking point, it is essential.
Most non-collateralized algorithmic stablecoins operate by reining in the stablecoin supply when the price begins to slip below nominal and increasing the supply when the price begins to jump above nominal. There are a number of different tactics for implementing these types of tokens, but the shared factor is that these stablecoins only have direct control over one side of the supply/demand balance—the supply.
Herein lies a potential problem. If a stablecoin has no kernel of intrinsic demand, then its demand must result purely from a collective belief in the stablecoin (EVH). Evidence thus far suggests that this type of collective-belief-based demand is volatile, as people individually or collectively change their minds or waiver in their beliefs about the stablecoin. If this collective-belief-based demand were fully uncorrelated amongst the participants, then appropriate modulation of the stablecoin supply could potentially hold the stablecoin itself at a steady price. Unfortunately, when collective-belief-based demand amasses around a stablecoin with no intrinsic demand, it tends to end up correlated or at least susceptible to correlation. Correlated actions and beliefs amongst participants can in turn pop an algorithmic stablecoin by driving detrimental feedback loops. The danger is that this type of demand can drop just as quickly as the stablecoin supply.
E-Stablecoin is different. E-Stablecoin does not rely on collective faith in the stablecoin to drive demand. Instead, it relies on the intrinsic demand for electricity. Since participants can “burn” E-Stablecoin tokens for electricity, the utility and demand for E-Stablecoin tokens is effectively divorced from any collective faith or allegiance to the token itself. Therefore E-Stablecoin has a much stronger feedback mechanism for maintaining price stability. Participants don’t have to want an E-Stablecoin token in and of itself—they want the electricity that it affords. Furthermore, the demand for electricity is ubiquitous and well established. The worldwide demand for electricity is less volatile and less correlated amongst participants than collective-belief-based demand. Thus, the demand for electricity cannot plummet in the same way that collective-belief-based demand can plummet, and E-Stablecoin does not rely on the Emergent Value Hypothesis.
Unfortunately the telephone game that is social media has led some to erroneously believe that E-Stablecoin is already implemented and available. E-Stablecoin is not available this year and won’t be available next year. The engineering advances that are necessary to truly implement E-Stablecoin will be challenging—think decades. Patience, of course, is the nature of scientific inquiry—much of today’s research will not pay off until decades into the future. Fortunately, none of the technologies necessary for E-Stablecoin are fantastical. Each key technology has already been designed, studied, and physically tested at some level. Furthermore, each of the key technologies is currently an area of active research and development for other applications. I am encouraged by famous historical examples of concepts that seemed well beyond human actualization at the time of proposal but nonetheless impacted the world only a few decades later. If we don’t invest in scientific inquiry, we doom ourselves to stagnation.