With the rise of blockchain-based stablecoins, the interplay between new forms of digital money and the two-tier banking system is again being challenged. Technology businesses are beginning to compete with financial institutions at the monetary unit level, as stablecoins provide consumers with a convenient, efficient, and reliable form of payment. Even the IMF argues that if the trend continues, the consequences for payment networks and monetary systems may be quite severe. Eventually, the global financial system – with its two most common forms of money: cash and bank deposits – might soon find itself in competition with e-money, i.e. stablecoins.
Why are stablecoins so popular?
Stablecoins were originally created as a trading instrument to quickly convert volatile cryptocurrencies into more stable currency substitutes and vice versa. Today, the main advantage derived by these blockchain-based stablecoins lies in the fact that investors and traders can transfer fiat-pegged money efficiently between exchanges, wallets, and custodians – without having to leave the crypto ecosystem at all.
The chart above illustrates the rise of stablecoins over time. Today, stablecoins account for over 50% of all trading volumes by pair denomination. The importance and popularity of stablecoins is even more noticeable when we consider the fact the FIAT and (especially) USD on/off-ramps have improved significantly on nearly all important trading venues since 2017.That being said, crypto trading volume against FIAT has greatly decreased and represents only a fraction of stablecoin pairs today.
However, the benefits of stablecoins clearly outweigh the drawbacks:
- Trading & Settlement
With no banks involved, traders have access to US dollar-like trading and settlement functionalities without depending on traditional wire transfers. This makes trading efficient and settlement instant. This applies to trading firms (arbitrage, cash management) as well as to retail investors (better UX).
- Cross-border payments
Why use Western Union or some other financial institution for remittances when you can have it instantly and at a fraction of the cost? The same goes for cross-border payments for financial as well as non-financial companies.
- Decentralised ﬁnance (DeFi) applications
Stablecoins play a vital role for many DeFi apps (liquidity pools, lending markets, on-chain asset management, etc.). The most popular stablecoins, e.g. USDT or USDC even come with multi-chain support, allowing users to switch between different protocols without having to convert into another crypto or FIAT currency along the way.
It goes without saying, of course, that if we scratch beneath the surface all types of stablecoins entail certain risks. While users of asset-backed stablecoins (e.g., Tether USDT) are mainly exposed to central counterparty risk, users of algorithmic stablecoins (e.g., Terra UST) face smart contract risk.
No threat to the monetary base
Will we now, or in the near future, see private companies, such as Tether, take over money creation? To assume that the FED (or any central bank) would give up its primary function at any time seems naive. Thomas Moser from the Swiss National Bank (SNB) also shared this belief during a recent presentation at the Crypto Valley Conference (CVC). In his view, handing over currency control will never happen completely, and the SNB will have no problem with privately issued e-money existing alongside stablecoins. Considering the rapid development in the space and shifting use cases over the last years, it seems apparent that stablecoins will not bring change to the monetary base, but rather only on the consumer/vendor transaction layer (labelled as broad money in the graphic below). This serves to make stablecoins an important driver for (crypto) adoption in the traditional financial world.
Source: The Block Research Stablecoin Report 03/10/21
Are we heading towards commercial adoption now?
Earlier this year, one of the major payment networks settled its first transaction in USDC. In March, Visa decided to become the first traditional financial institution to support settlement in USDC. By collaborating with the first federally chartered digital asset bank, Anchorage, Visa is piloting this capability with Crypto.com, one of the largest crypto platforms out there. In order to settle USDC transactions, Crypto.com just sends USDC directly to Visa without having to convert into USD. This marks a huge step in adoption, since crypto apps/commerce providers are no longer required to support or integrate with the legacy system.
MasterCard joined the party a few months later, when they announced a partnership with Evolve Bank & Trust, Paxos, as well as Circle (the issuer behind USDC). An executive VP stated: “Today, not all crypto companies have the foundational infrastructure to convert cryptocurrency to traditional fiat currency, and we’re making it easier.” This essentially means that the two largest electronic payment companies in the world are pivoting more and more away from the legacy system, and are starting to build new offerings directly on blockchain-based financial infrastructure (Ethereum, in this case). Visa is demonstrating this claim by pushing their product/service offering ahead with its first crypto rewards credit card together with Fireblocks and its interoperability platform between private stablecoins and public CBDCs.
At the same time, regulatory concerns are diminishing. After U.S. Treasury Secretary, Janet Yellen, demanded to “quickly ensure there is an appropriate U.S. regulatory framework in place [for stablecoins]” last summer, the crypto lobby has become active. As a result, the Washington-based Chamber of Digital Commerce (its members include Goldman Sachs and Citigroup) told U.S. regulators last month that stablecoins should not face a new set of rules simply because new technology is being deployed.
With regulatory clarity on the horizon, the separation of the wheat from the chaff has begun. Although the Hong Kong-based stablecoin issuer, Tether Limited, is still the dominant player based on volume and circulating supply, USDT might find itself struggling to maintain its market share if it does not manage to polish its image and enhance transparency.
As of now, all signs are clearly pointing in one direction: Circle will lead the way with USDC when it comes to global commercial adoption outside of the crypto ecosystem. Not only because the two major payment networks are adopting it, but also because Circle thinks bigger. The company commits itself to working towards the big picture which started with bitcoin more than a decade ago: to democratise the financial system. To do this, Circle recently started an important initiative called “Circle Impact”, which aims to improve financial inclusion and economic prosperity for all. As a part of this initiative, it is planned to “direct billions of dollars of USDC reserves to Community Banks and Minority Depository Institutions (MDIs) throughout the United States”. Alongside fostering the USDC network and funding programmes for start-ups, Circle tackles one of the root causes of financial exclusion with their Digital Finance Literacy Initiative. In collaboration with leading Historically Black Colleges and Universities (HBCUs) in the United States and other leading institutions, they want to ensure that the digital financial revolution is accessible to everyone.
It seems that adoption of a parallel internet-native financial ecosystem for the average consumer is evolving more rapidly than some might have expected. My best guess right now is that this trend will accelerate as soon as more “analogue” service providers realise the huge business potential, and more non-crypto consumers can experience the benefits provided by blockchain-based stablecoins.
Of course, only if regulators do not stop the party…