What Is Basecoin?
Basecoin was a cryptocurrency launched in 2018 whose protocol was designed to keep its price stable. At launch, its value was pegged to the U.S. dollar. Basecoin was designed to help investors have a store of value that wasn't plagued by the wild fluctuations in price that most cryptocurrencies, such as Bitcoin, experience. After intervention by the U.S. Securities and Exchange Commission (SEC), Basecoin (renamed Basis) was shut down in December of 2018.
- Basecoin was a cryptocurrency in 2018 that claimed to cut price volatility by pegging the coin to an underlying security.
- The concept came under criticism from crypto enthusiasts and economists because it misunderstood the mechanism of securing the value of a currency.
- The inventor of Basecoin announced in December 2018 that Basis, the parent of Basecoin, would shut down and return money to investors.
- Basecoin's story is emblematic of the Crypto Mania gripped investors from 2016 to 2019.
How Basecoin Worked
Basecoin was founded by Nader Al-Naji and his two former Princeton classmates Josh Chen and Lawrence Diao. Basecoin labeled its tokens as “stable,” meaning that the value could be pegged to another asset. These types of cryptocurrencies are called stablecoins, which were designed to reduce the high price fluctuations—called volatility— that many cryptocurrencies experience.
A single Basecoin could be pegged to the U.S. dollar (USD), a basket of assets, or an index, such as the Consumer Price Index (CPI). CPI measures the price increases for a basket of consumer goods and is an indicator of rising prices—called inflation—in an economy. At launch, it used the U.S. dollar as a peg. The company claimed that it algorithmically adjusted the supply of its tokens based on the exchange rate between it and the peg. For example, one BASE would always be worth one U.S. dollar.
The Basecoin protocol was decentralized, which made it difficult to verify how the market valued its tokens. The system had to rely on data provided by third parties, and adjusted the number of tokens it issued based on how the market valued them. It did this using three different tokens:
- Base Bonds
- Base Shares
Base Shares were held by investors who bought into Basecoin early on but were not the same as stocks. Base Bonds were not the same as a typical bond or debt instrument, but instead, were similar to options and futures contracts, which are derivatives since they derive their value from an underlying asset.
If the value of a token was higher than a dollar, Basecoin would release more tokens to holders of Base Shares. It did not release them to the open market directly and instead allowed Base Shares holders to sell the tokens. This roundabout approach was supposed to increase the overall supply until the value of one Basecoin returns to parity with the USD.
If the value of a token is lower than a dollar, Basecoin would release Base Bonds, which could be converted into Basecoin once Basecoin reached parity with its underlying asset. This conversion was done on a first-come, first-serve basis, meaning that early investors were theoretically able to cash out before later ones.
Basecoin is not the first company to claim to have a stable coin, as Bitshares attempted this with BitUSD in 2014. That venture was not successful. The central banks of developed countries abandoned one of the more famous currency pegs, the gold standard because they were no longer able to maintain the peg. This occurred because there was a mismatch between what the market thought pegged currencies were worth and what the central banks said they were worth. Making up for this difference ate through reserves leading to its abandonment globally in the 1970s.
Concerns about Basecoin
Basecoin’s claim that this three-pronged approach to managing token value is similar to how central banks operate was met with skepticism.
Economists like John Cochrane, writer of the Grumpy Economist blog, pointed out flaws in the economic theory behind Basecoin. In some cases, the whitepaper outlining how Basecoin functions confused fiscal policy with monetary policy, underlining how little the technologists of new money knew about the theory of money in 2018.
According to Cochrane, Central banks typically manage the supply of money by buying and selling securities. If a central bank wants to increase the quantity of money in circulation, it buys securities from banks and other financial institutions. It does not create its own securities.
Basecoin, on the other hand, created a situation where drops in Basecoin price were secured by Base Bonds that had no value because they were meant to be as liquid as Base Shares and the coin itself. Cochrane says, "Basecoin buyers will soon learn the lesson that bonds cannot pay more interest than money in a liquid market and that claims to future seigniorage cannot back money in the face of competitive currencies."
As Chochrane said, "It is interesting to me how the cryptocurrency community seems to be painfully re-learning centuries-old lessons in monetary economics." Though Basecoin tried to solve the crypto volatility problem by pegging the coin to an asset, the mechanism supporting the peg was purely self-referential (instead of having a true one-to-one relationship between the digital coin and hard currency reserves).
How Is Basecoin Different from Tether (USDT)
Tether (USDT) is a fiat-collateralized stablecoin, meaning it's backed by a fiat currency such as the U.S. dollar. Tether holds dollars—called reserves—as collateral to back the currency. The reserves are held with an independent financial institution. The value of Tether is approximately one dollar since it's pegged to the dollar.
Conversely, Basecoin didn't have any reserves of a fiat currency backing it but instead, promised to increase or decrease its currency supply to match the fluctuations in the dollar exchange rate with Basecoin.
Regulation by the SEC and Basis Shutdown
Basecoin changed its name to Basis in 2018. It was one of the most well-funded coins that year, but that notoriety attracted the scrutiny of government regulators, including the Securities and Exchange Commission (SEC) at a time when initial coin offering (ICO) mania had made and lost fortunes around the world.
Nader Al-Naji, CEO of Basis, wrote a letter on December 13, 2018, that announced Basis would be giving its investors back their money and that Basecoin would cease to exist. In the letter, Al-Naji says the SEC's requirements to "put transfer restrictions on bond and share tokens" (for example, people outside the U.S. could not hold them) and create a centralized whitelist made the mechanism Basecoin operated on unsustainable.