And comparative remarks with Maker / Dai
Rejecting the Euro
In the year 2000, the Danish people rejected a referendum to adopt the Euro by 53% to 47% . Previously, Denmark stayed outside of the Euro as a result of rejecting the Maastrict treaty in 1992.
Denmark maintains its own sovereign currency, the Danish Krone (DKK). It’s value – since about 1995 – has been pegged to the Euro at a rate of 7.46 +/- 2.25%. The Danish central bank maintains interest rates on the Danish Krone very close to those of the Euro. Functionally, using Danish Krone is identical to using Euro.
The Beauty of the Krone
If the Krone is pegged to the Euro, why simply adopt the Euro?
In short, Denmark retains the ability to swap what the Krone is pegged to and the ability to control its reserve holdings. In its 20th century history, the Krone has been pegged to gold, the German Reichsmark, the British Pound, the Dollar, and the Euro. If the Euro were to come under pressure, the Danes could choose to peg instead to the British pound, the US dollar, or some other currency. Indeed, fear over the future of the Euro is what – in part – led to the rejection of the referendum to adopt the Euro in 2000.
What allows the Krone to keep it’s value?
The Krone is primarily backed by a Central bank reserve of Euro denominated currency and bonds.
The Danish central bank had assets of about 570 billion Danish Krones (about 76 billion Euro) at the start of 2022. Against these assets, the two biggest liabilities were notes and coin in circulation + deposits from residents (266 billion Krones), and central government deposits in Krones (171 billion Krones). Rounding out liabilities (ignoring other smaller items), the Central Bank had additionally had capital and reserves of 81 billion Krones, meaning the central bank assets include a surplus of about 17% over non-capital/reserve liabilities. This can be thought of as a safety buffer.
Taking a look at Danish Central Bank’s international investment position – which accounts for the majority of it’s reserves – one sees that most assets are denominated in Euro. The second largest denomination of holdings is the US dollar, with holdings of Japanese yen contributing too over the last five years:
Almost all of the Danish Central Bank’s reserves are held in deposits or in bonds, allowing interest to be earned that can be used to pay interest on the Danish Krone.
DAI: A non-state pegged currency
DAI is a non-state currency that is pegged to the US dollar. There are about 6 billion US dollars worth of DAI in circulation, and the currency is backed by a reserve that consists mostly of US dollar stablecoins (digital dollars backed by US dollars in bank accounts – at least according to attestation reports). At the time of writing, reserve assets included an excess of about 24% over issued currency.
Maker is the organisation that operates DAI. Maker earns some interest on a portion of its reserves and uses some of those earnings to pay interest to DAI depositors. This is analogous to the Danish central bank earning interest on Euro and using it to pay interest to depositors of Danish Krones.
Like the Danish Krone, DAI can – with a majority vote of Maker organisation members/tokenholders – vote to have DAI track the price of another currency (e.g. Euro or Yen) or indeed not track any currency at all.
If you live in a country without a relatively stable currency like the Euro, you also won’t have easy access to the Danish Krone. What’s interesting about DAI is that it’s an internet currency. Anyone who has access to the internet can benefit from the stability of DAI (although local governments may choose to make DAI illegal).
Staying on good terms
Since the Danish central bank has lots of its reserve in Euro and US dollars, it’s pretty important for Denmark to stay on good terms with the US and the Eurozone. If the Euro or US deposits were suddenly to be blocked, then the value of the Krone could plummet.
Likewise, since Maker has dollar denominated reserves, it’s important for Maker to have good relations with the US government (and any intermediaries like Circle, Gemini, Coinbase and Paxos that are involved in the digital dollar currencies). If Maker’s US dollar reserves get blocked, the price of DAI could plummet. This risk became real in 2022 when a number of digital dollar tokens (USDC) were blacklisted by the US Office of Foreign Assets Control. The blacklisting had nothing to do with Maker and – in this specific case – didn’t affect tokens in the reserve. The intent of US government action was to address North Korean government money laundering. However, since the government action was applied to all tokens involved with Tornado cash (a privacy protocol), irrespective of whether the tokens were involved in money laundering, this introduced the risk for Maker that its reserve holdings (which included USDC) could become collateral damage in future government actions against money laundering.
And so, absent Maker and the US government finding an agreement that addresses their mutual concerns (and there isn’t a whole lot of precedent for an internet organisation reaching agreement with a state government), Maker’s option is to replace US denominated reserve assets with the reserve currency of another organisation. Ether, the reserve currency of the Ethereum organisation – another internet organisation – is a natural choice. However, being a young organisation and currency, Ether (the currency) is a volatile asset, requiring much more to be held in reserve percentage-wise in order to back a dollar pegged currency.
Today Maker is a hybrid that makes use of both dollar-denominated and Ether-denominated currencies in its reserve (as well as smaller amounts of other currencies), but, with a stated goal of winding down dollar-denominated reserves. LUSD, another digital currency that loosely tracks the dollar, already makes sole use of Ether as a reserve currency. It was deployed purely as code and has no managing organisation, meaning that there can be no change its reserve policy without deploying a new currency.
Organisations continue to emerge and grow in the digital realm. There are important choices for the public to be aware of and to make – around privacy, around safeguards against money laundering, and around global financial access.