Source: Digital Bytes
Stablecoins – cryptocurrencies whose value is (typically) backed by a reserve of assets pegged to a fiat currency like USD – are gaining traction as a new ‘digital asset’ in their own right, and as a potential opportunity for change in traditional financial markets and transaction workflows. Specifically, many payment service providers are considering the potential opportunities presented by this new ‘crypto’ medium of exchange and how they might challenge the traditional, bank-dominated payments status quo.
Created initially as an alternative, less risky, route to crypto investment (and for converting crypto/alt coins into fungible tokens), stablecoins are designed to maintain a more ‘stable’, less volatile value compared to the ‘big boy’ cryptos like Bitcoin and Ethereum – (interestingly, stablecoin can be ‘pegged’ to Bitcoin but that’s an article for another day). Whilst similar in concept to central bank digital currencies (CBDCs) – also very much on the radar in financial markets with respect to their potential in the payments space – there are some fundamental differences between CBDCs and stablecoins. The biggest difference is that CBDCs are, in the main, still at the theoretical, design stage while stablecoins are ‘live’ for specific use cases, and as such are subject to increasing regulatory scrutiny in key geographies. In the UK, fiat-backed stablecoins are slated to be covered by secondary legislation under the Financial Services and Markets Bill 2022-23; new EU Markets in Crypto Assets (MiCA) Regulation will govern issuance and provision of services related to stablecoins (and other crypto assets) while the US SEC is taking a more hard-line view with respect to whether and how stablecoins should be subject to existing Securities regulation.
Stablecoins can be issued and governed by regulated banks and non-bank entities, while, and as their name implies, CBDCs are issued and controlled by central banks. Both use blockchain as the facilitating technology (although CBDCs can also be built on a centralised architecture). While CBDC designs will likely require permissioned, private blockchain structures, stablecoins benefit from being able to leverage multiple open source and permissionless blockchains, and the associated DLT technology within them. Further, stablecoins can be stored in any compatible digital wallet, whereas CBDCs may require a proprietary, government-issued (or other authorised intermediary) wallet. Central bank ‘ownership’ of CBDCs is geographically restrictive since they are being developed primarily for domestic application; while they may have an eye on cross-border interoperability, there are no guarantees around this. Stablecoins, however, have no such geographical constraints and can be used – in principle – as a ‘medium of exchange’ anywhere in the world (as individual regulatory jurisdictions allow).
Looking just at stablecoins, let’s dive a bit deeper into their potential merits and weaknesses as an alternative ‘medium of exchange’:
| PROS
Better, faster, cheaper option to fiat currency? |
CONS
Still early days – financial markets caution? |
| Stability
Underlying blockchain technology is potentially more stable and transparent than fiat currency infrastructure. |
Stability
A number of stablecoins have already failed, including Terra, whose disintegration may have contributed to FTX’s demise. |
| Less transactional/KYC risk
DLT only ‘allows’ validated entities to access the blockchain, and creates an immutable record of transactions providing for greater transparency and reducing KY counterparty risk. Faster, assured settlement “Atomic” (T+0) settlement: Transactions completed securely and efficiently in seconds. |
Pegging risks
While the transactional risk of a Stablecoin becoming ‘unpegged’ from an underlying fiat currency is quite small, given the likely speed of the transaction (and instantaneous conversion to fiat) some Central Banks are concerned with the risks attached to non-sovereign reserves used to back stablecoin. (The US Fed likens these to the risk associated with money market funds). |
| More accessible, inclusive ‘medium of exchange’
Stablecoin (and CBCs) are a potentially more “accessible’ way of making and receiving payments, both with respect to ‘under-served’ banking segments like SMEs and crypto-native businesses and from a more socio-economic perspective, the ‘unbanked’ Remitting digital currency payments to a digital wallet removes the obligation to hold bank accounts. (This latter aspect is considered a particularly key benefit of CBDCs.) |
Regulation (or lack thereof)
The traditional payments model operates within an established regulatory framework (of wholesale, retail and consumer protections) and global standards e.g. SWIFT messaging. While regulation is in hand in certain jurisdictions for Stablecoin e.g. its proposed inclusion as an asset class in UK’s Financial Services Bill, different jurisdictions have different approaches. The US Fed, for example, is hostile towards digital assets in toto; other countries might simply prohibit their use. |
| Greater security/privacy
Sharing of sensitive data associated with traditional banking/payments channels not required; validated digital ID is attached to the Stablecoin on a secure chain. As such, there is less risk of fraud/identity theft from having to share data with multiple intermediaries. |
Issuer risk
Tether (USDT), currently with the largest share of the stablecoin market, has been fined often by regulators for lack of transparency about the quality of its ‘backing’ reserves. It is also associated with FTX. Others, like Circle and Paxos are being investigated by US regulatory authorities. |
| Cost efficiencies
Potentially more attractive to SME/crypto- native segments currently under-served and over-charged in the traditional banks payment model. |
Too new to be trusted
There is a lot of industry cynicism about the merit and worth of digital assets, including stablecoins. The lack of market regulation and associated transparency and scrutiny issues may make the burgeoning crypto and digital asset industry still too much of a ‘Wild West’ for a naturally cautious professional financial community. |
Source: Digital Bytes
There is no question that the traditional bank-dominated payments model is ripe for change and is already being challenged by the advent of multiple non-bank, fintech-native PSPs (payment service providers). In particular, they seek to address common issues in the payments value chain, including payments speeds of 3-5 days against potential ‘atomic’ (T+)) settlement for digital assets on blockchain, and lack of transparency around missing payments. These new ‘challengers’ also recognise that the traditional ‘correspondent banking’ model is somewhat exclusive and discriminates against smaller firms (and new crypto/digital businesses), both in terms of volume-linked transaction cost scale benefits (how much they are worth as a customer to any bank) and overall from the higher cost of doing business associated with their (relatively) higher risk profiles.
Freemarket’s approach seeks to address this imbalance through its aggregation of many bank and Non-Bank Financial Institution connections for efficient cross border payments and currency conversions. By considering the inclusion of stablecoins as a payments and FX currency option, these customers can potentially benefit further from a faster, more stable, more secure and more transparent medium of exchange that leverages blockchain and DLT technologies to assure sender/recipient identities and create immutable transaction records – all of which are potentially ‘at risk’ with traditional payments transactions.
We are ‘watching this space’ with interest.