Stablecoins: What They Mean For The Future Of Money
Most people are aware of cryptocurrencies, especially bitcoin, which is the most well-known. Some have become millionaires due to its unabated growth and accompanying roller-coaster volatility, while many investors have frequently suffered significant losses, particularly in recent months.
In a white paper published in 2008, Satoshi Nakamoto, who is thought to be a person or group of persons using a pseudonym, first proposed the concept of bitcoin. It characterized bitcoin as “a completely peer-to-peer version of electronic cash would allow internet payments to be transmitted directly from one party to another without passing through a banking institution.”
Up to a point, the initial concept behind bitcoin is sound. Because it is unstable, it fails to function well as a medium of exchange or reserve money. In actuality, it is rather volatile. Volatility in the financial realm refers to how an asset’s price fluctuates around its average. In contrast to US investment grade bonds, which have a volatility of 5%, equities, as measured by the S&P 500, have a volatility of 21%. Currently, the volatility of bitcoin is 85.15%.
Stablecoins: What are they?
Stablecoins aimed to address the issue of volatility. Their goal is to resemble conventional currencies while using the advantages of blockchain technology.
In essence, blockchain is a digital ledger of transactions that offers advantages like transparency, security, immutability, digital wallets, quick transactions, low fees, programmability, and privacy without sacrificing the trust and stability that use the traditional currency.
Stablecoins are distinct since private persons rather than banks can hold them. Instead of being held in a bank account, digital cash is kept in your digital wallet. Of course, reserves have served as a type of digital money within the banking system for many years.
Stablecoins and digital currencies are distinct from bitcoin, which many people mistake for digital gold. The value of a stablecoin is derived from its peg to a fiat currency, such as the dollar. Bitcoin’s value is derived partly from the expenses associated with producing or “mine” new coins and from market demand. This value is comparable to that of gold, where it exceeds the cost of mining, recycling, and storage.
A strict regulatory system would also raise entrance barriers, which lowers risk.
This is logical. We believe that to monitor reserve requirements, regulators should use distributed ledger technology’s transparency, allowing for real-time observation. Regulation will determine the stability (water-tight reserves) element of design.
The environment of stablecoins will be drastically altered by regulation and central bank digital currencies.
Currently, private enterprises produce the majority of stablecoins, but this will change as central banks introduce their own, referred to as CBDCs (central bank digital currencies). In March 2022, President Biden signed an executive order establishing the foundation for a Federal Reserve (Fed) CBDC. Later this year, the results are anticipated.
Although it is still in the experimental phase, the eurozone is slightly ahead. According to the European Central Bank, a digital euro would probably include smart contracts.
Since 2020, the Bank of England and HM Treasury have investigated a sterling CBDC. A consultation procedure that will assess the key concerns is currently in progress. The earliest that a sterling CBDC will be seen is expected to be in the middle of this decade.
Many nations are now engaged in research. Interoperability between different CBDCs is something we would like to see in a perfect world. On a common platform, the Bank of International Settlements is currently testing this with four central banks. The advantages of a publicly issued digital dollar vs. one issued for business purposes have been hotly contested.
Giving individuals and businesses a direct banking line to the Fed would, on the one hand, undercut the commercial banking system by lowering the volume of bank deposits and the banks’ ability to lend. On the other side, a currency produced by the Fed reduces the systemic risk posed by private providers.
It is important to note that, similar to how the Eurodollar banking system functions, an offshore commercially-issued USD stablecoin can exist regardless of what US regulators decide. Eurodollar deposits are made in dollars and are not governed by US laws.
— Adviser Home (@adviserhome) July 20, 2022
Both a CBDC and a business stablecoin can promote innovation. Both sides, in our opinion, are missing the mark. The choice is not black or white, and design is the key consideration from an innovation standpoint. The most crucial query is designed once the reserving is regulated, which is, in our opinion, a crucial prerequisite for acceptance.
Why does this matter? In essence, the discussion revolves around privacy. Should the properties of a dollar coin apply to digital dollars as well? Should a government be allowed to keep an eye on how much money is spent on each transaction? What about transactions that are just above a specific amount? Should a government have the authority to take the platform away from someone or something financially? In non-democracies, how does this operate?
Digital wallets are the way of the future of money.
Knowing your customer (KYC), money laundering, and other illegal acts were all extensively covered by the March 2022 White House Executive Order.
The leadership in financial innovation centered on improving the payment system and cross-border remittance, however, was more intriguing:
Appropriately developing payment technologies and digital assets is one way to strengthen the United States’ leadership in the global financial system and technological and economic competitiveness.
Recently, the UK has also realized the value of creating digital asset technologies. When speaking in April 2022, Rishi Sunak said:
“It’s my goal to establish the UK as a leader in crypto-asset technology, and the steps we’ve taken today will make it possible for businesses to expand, create, and invest here.”
Stablecoins will be regulated, opening the door for their acceptance as a recognized form of payment in the UK.
Exchange of digital assets
Tether served as the first stablecoin use case in the cryptocurrency industry in 2014. Trading back and forth between the “fiat” (conventional currency) and the crypto world was exceedingly challenging and expensive. To purchase cryptocurrency, one must transfer funds from their bank to exchange. The market was inefficient because of compliance regulations and transaction times, especially as digital assets trade continuously. This was solved with stablecoins. Crypto trading is still the most significant use case regarding market cap and daily changes. We believe that this will alter when adoption spreads in the real world.
Since these new currencies would be kept in mobile digital wallets, anyone with a smartphone and internet can open an interest-bearing USD current account without using the banking system. Users will be able to instantly and virtually for free transmit their currency throughout the world in addition to making payments. This affects networks, platforms, and banks that issue credit and debit cards.
Since an increasing number of remittance payments are already made through this manner, the use case has already been put to the test. When a stablecoin transaction costs less than 0.1 percent, cross-border payment processors will no longer be allowed to charge 3 to 6 percent for cross-border retail payments.
Large portions of the correspondence banking system are also in danger, so retail payments are not the only industry that could see disruption. For instance, it may take a week to settle a payment from an Indian SME to an Indonesian SME and may include up to six banks and a total charge of 3%.
Alternately, users can trade a dollar stablecoin with immediate settlement for a far lower price. For regional fintech that specializes in payments, we see this as advantageous.
There is a chance that stablecoins will interfere with the SWIFT network. Due to the US government’s removal of significant Russian banks from the network, the SWIFT messaging system has recently received attention about Russian sanctions. Since SWIFT is a messaging system for cross-border interbank transactions, parties who are blocked from the network find it difficult to conduct business globally.
Because everyone with a wallet can transfer to another wallet anywhere, stablecoins do not require SWIFT. As a result, we observe some form of control built into most CBDCs and stablecoins used in mature markets, such as identities connected to wallets.
It is also possible that domestic payment networks will operate more effectively. Currently projected to be around 2.2 percent of a transaction, credit card fees—typically paid by the merchant—have grown at a compound annual rate of 8% over the preceding ten years.
Stablecoin issuers are beginning to collaborate with credit card firms. A project with Mastercard was piloted by stablecoin issuer PAXO. Using the stablecoin payment system, Visa has also completed transactions. Many conventional businesses, whether they’re offering conventional financial services to stablecoin businesses or allowing on-ramp payments to and from the digital realm, are crucial players in the ecosystem in our eyes.
Significant change is now occurring in the video game industry. Characters and in-game items are typically the property of the developer. By using distributed ledger technology, ownership can be transferred to the player of an item, such as a legendary sword or a virtual tennis racket. Using a stablecoin instead of fiat money to accomplish these transactions is more affordable, simpler, and quicker.
Smart contracts integrated into a CBDC allow stablecoins to be “programmable” as well. This will make it possible for focused fiscal and monetary policies.
- Targeted fiscal spending – For instance, a government could target farmers with a stablecoin that could only be used to purchase farming equipment under the supervision of the embedded smart contract.
- Interest rates based on holdings – Savings from the lowest income bands have suffered due to the past ten years of low-interest rates since they have limited access to financial products. A programable CBCD has the advantage of a tiered interest rate structure, in which assets below a certain threshold—say, $10,000—have a greater rate than those above.
- Direct payments to households: Covid has shown that broad government transfer payments, also known as “helicopter money,” are necessary. The World Bank estimates that cash payments were made to 17% of the global population. There are currently a lot of middlemen who make this possible, which causes leakage. This could be more productive with a CBCD.
Dollarization in EM economies
Stablecoin adoption on a big scale would significantly affect deposit-taking banks and financial penetration since stablecoins in a wallet would operate as a current account in practice. Converting local currency deposits into a stablecoin pegged to the US dollar, for instance, might advance the dollarization of emerging economies. The fear of this possible conclusion contributes to the strict stance against bitcoin by nations like China and Turkey.
Successful stablecoins must handle this problem and others, but they may still result in significant bank disintermediation.
A CBDC has a geopolitical component because it has its payment system. One concern would be that the lack of a digital euro will diminish the European Union’s strategic independence. Since markets may be easily created between non-traditional currency pairs, this will also impact FX trading. There won’t be any requirement to trade through a significant institution. Once more, this helps developing markets.
Financial inclusion made possible
Financial products will be able to become open-sourced and programmable thanks to digital wallets. According to the most recent official data from the World Bank (2017), 1.7 billion adults worldwide (or just under one-third) are still “unbanked” or not part of the established financial system. Anyone with a smartphone and internet access can keep, send, and spend fiat currency thanks to stablecoins and digital wallets.
In line with UN Sustainable Development Goal 9, we see this becoming ingrained on a global scale. We think the “underbanked,” a demographic with restricted access to financial products, represents the true opportunity. According to a 2019 Fed research, 22% of adult Americans lack adequate banking services. In emerging markets, this number is substantially greater.
The first practical use for digital assets has been made possible by stablecoins, which provide a quicker and less expensive alternative to payment processing and overseas transfers.
As stablecoin payment infrastructure spreads across continents and many governments are already working toward some kind of regulation, we see this as an 18-month story in innovation. The economic benefits alone make it worthwhile to take the time and effort necessary to properly regulate them. The less fortunate are the group that stands to gain the most from this.
We anticipate that the impact of digital wallets will grow over time as they increase access to financial services for underbanked people. As this progresses, we’ll be paying close attention.