Celo: A Decentralized Financial Future Built for the Unbanked

Celo: A Decentralized Financial Future Built for the UnbankedCelo is a platform that aims to enable global payments with cryptocurrency for anyone, using their mobile phone. To achieve this ambitious goal, Celo relies on decentralized application (dApp) developers to build solutions

Celo: A Decentralized Financial Future Built for the Unbanked

Celo is a platform that aims to enable global payments with cryptocurrency for anyone, using their mobile phone. To achieve this ambitious goal, Celo relies on decentralized application (dApp) developers to build solutions. Celo's smart contract compatibility provides strong support for developers. dApps built on Celo have a wide range of applications, from traditional remittances to providing universal basic income for extremely poor communities. Celo is committed to bringing a future of inclusive finance to those excluded from the financial system.

The key pillars of Celo's global adoption are stablecoins as a medium of exchange and mobile wallets as a payment method. To accommodate mobile use, Celo has adjusted its proof-of-stake blockchain, optimizing block headers for mobile synchronization. Additionally, gas fees can be paid in multiple currencies, catering to users with diverse asset holdings.

Celo Stablecoins and Their Stabilization Mechanism

The Celo stabilization mechanism relies on two different types of tokens. The first is represented by elastic supply stablecoins pegged to fiat currencies, such as CeloDollar (cUSD) and CeloEuro (cEUR). The second is CELO, a fixed supply governance and utility token with a floating value within the system.

The dual-token system maintains the peg of Celo stablecoins to fiat currencies by adjusting the supply and demand of CELO tokens. To provide an additional safety buffer, Celo also uses a diversified basket of cryptocurrencies as reserves to support the peg. Therefore, this stability mechanism can be defined as a hybrid crypto-collateralized/seigniorage model.

The reserves currently equate to eight times the amount of outstanding stablecoins issued by Celo, with 76% composed of CELO tokens. The remainder consists of BTC, ETH, other stablecoins (like DAI), and nature-backed assets (like tokenized cMCO2), a version of carbon credits. By allocating a portion of reserve assets to natural capital, the reserves can create an incentive mechanism that aligns demand for stablecoins with natural capital protection and functions as a massive carbon sink.

Market participants can maintain the dollar-peg (or cEUR) price of Celo Dollar in line with parity by profiting when deviations occur. This mechanism, called Mento, allows CELO token holders to exchange CELO worth one dollar for one CeloDollar. When demand for CeloDollar rises and the market price is above the target, arbitrage profits can be realized by exchanging CELO worth $1 for 1 CeloDollar and selling that CeloDollar at the market price. Similarly, when demand for CeloDollar falls and the market price is below the target, arbitrage profits can be realized by buying CeloDollars at the market price, exchanging them with the protocol for CELO worth $1, and then selling the CELO to the market. This allows market participants to keep the Celo Dollar price at $1 with minimal intervention from the protocol.

It is worth noting that there is a variant of the Mento mechanism called GrandaMento, which is used when the protocol needs to exchange a large amount of CELO for Celo stablecoins to avoid excessive slippage.

The existence of multiple stablecoins on the Celo ecosystem helps to ensure that the platform and projects that aim to deliver products and services with global impact are flexible enough to meet the needs of customers around the world. Stablecoins pegged to the dollar may not be suitable for payments in countries that use different fiat currencies. Therefore, Celo allows users to create multiple stablecoins. The cEUR stablecoin pegged to the euro was launched at the beginning of 2021, and other stablecoins can be added in the future to track currencies like the Japanese Yen or Brazilian Real. The stability of each stablecoin is managed independently through a specific Mento mechanism.

Introducing new stablecoins through a governance process ensures the platform's sustainability. To avoid the negative impact of a new asset on the stability of other tokens (for example, if it has high volatility), Celo uses a bonded proof-of-stake model to vote on new introductions. Celo holders will only vote in favor of a new stablecoin if they believe this stablecoin can experience stable and sustainable growth without harming the ecosystem.

Finally, it is worth noting that the reserve pools for all stablecoins do not need to be the same. Reserves can be created based on the specific characteristics of the stablecoin and the use case it will be used for. For example, in the case of using a stablecoin to pay remittances in a local community, some local reserve currency could be distributed to local residents which would allow them to benefit from the adoption of the local stablecoin, as a kind of social dividend.

Mobile Wallets for a Global Reach

Wallets are essential tools for managing cryptocurrency payments. Most of them are not as instant as smartphones and are not easily accessible for communities that do not have access to personal computers. Celo aims to expand its customer base and improve the user experience of using cryptocurrency payments by introducing a phone number-based identity system. This mechanism links a phone number to a Celo address, making the phone number act as the wallet address when instructing payments. This approach doesnt compromise user privacy because the hash plus a pseudo-random pepper of the phone number is stored on the blockchain, without the actual phone number being shared.

Celo public addresses allow users to attach multiple phone numbers to the same address, change the associated number, and/or revoke them at any time. Mobile phones are not the only tool users can use, since any device that can receive secure messages can be used, like an IP address or bank routing and account numbers.

Finally, attaching a phone number to a Celo address enables reputation capture (such as credit scores). Celo has adopted EigenTrust, a decentralized algorithm where the score of a phone number is defined by the number of other phone numbers that trust it, weighted by their own reputation scores (similar to how PageRank works).

While making payments among a small group of known individuals doesnt pose a specific trust problem, when it comes to executing transactions with people outside the direct circle of contacts, it is useful for users to be able to aggregate trust signals from their inner circles.

Regulatory Stance on Stablecoins

Stablecoins are representations of fiat currencies on the blockchain. It is no surprise that financial and monetary regulators are intensifying their efforts to understand the potential implications of stablecoin use for consumer protection and financial stability. The US Treasury recently met with several industry participants to discuss the risks and benefits posed by stablecoins.

Two primary concerns from regulators are as follows:

- Bank Run Scenario: If, at some point in time, a significant number of customers wanted to redeem their stablecoins for the underlying fiat currency, stablecoin issuers may not be able to service all customers if reserves are insufficient or inadequate.

- Monetary Policy Effectiveness: There may be a significant disconnect between the return on a dollar in the real economy and the return on a dollar on the blockchain. In some situations, the returns on these fiat currencies are even negative. This difference could lead people to move savings from traditional financial institutions, thereby diminishing the effectiveness of monetary policy.

The risk of this happening became palpable when Coinbase announced the launch of its Lend functionality that would give USDC depositors a 4% annual interest rate. Coinbases Chief Legal Officer wrote that if the company were to launch such a product, the SEC threatened to sue the company. According to Brian Armstrong -- Coinbases CEO the SEC informed the company that their lending functionality would be considered a security, meaning that it would be regulated as an investment.

What are the most likely regulatory measures that will be taken to address these two concerns? A recent paper titled Taming Wildcat Stablecoins written by two Federal Reserve economists may provide some framework to understand what the pillars of the upcoming regulatory framework for stablecoins may be:

- Treat stablecoins as bank deposits: This would force stablecoin issuers to operate within licensed banks. Stablecoin issuers could either become licensed banks themselves or choose to operate their stablecoin activities by partnering with licensed banks (Facebooks plan for its stablecoin Diem was reportedly to use a licensed bank). If stablecoins are sold to retail clients, this effectively amounts to taking retail deposits and the law would also require banks to conduct FDIC insurance.

- Designate stablecoins as systemically important payment tools: This would empower the Fed to implement stricter controls and more intensive monitoring of the risk-management activities carried out by stablecoin issuers. The authors suggest that the Fed could then either require that FDIC-insured banks issue stablecoins or require that stablecoins issuers hold cash reserves at the Fed on a one-for-one basis (that is, converting stablecoins into public money).

- Replace stablecoins with public digital money in the form of Central Bank Digital Currency (CBDC): One of the main goals of CBDC is to protect the dollar from competing forms of private digital money. Being forced to ensure complete compliance with Fed regulations would effectively tether stablecoins to US monetary governance.

Retaliation from other countries may be a potential way out of this situation. China, Russia, and the EU have all taken measures or have expressed concerns with moving away from a US dollar-dominated financial system. These three countries are also actively regulating cryptocurrencies or starting to build their own digital currencies. If sovereign-backed stablecoins emerge, it is highly likely that these countries will issue stablecoins backed by their own currencies to the wider cryptocurrency market. CBDCs, private