As the cross-border payments landscape changes and digital currency exchanges evolve for more practical day-to-day use, one of the most important obstacles to solve has long been the stability of popular cryptocurrencies and digital assets.
The speculative trading of assets such as Bitcoin or Ethereum has caused volatile fluctuations in their value and cast doubt in the minds of mainstream businesses that could otherwise benefit from a blockchain-based payment system.
One of the main issues was that these speculative cryptocurrencies were not pegged to the US dollar.
Enter stablecoins, a blockchain-based token that can be linked to hard dollars on a one-to-one relationship that can be redeemed by an issuer, which typically holds reserve assets in cash or investment-grade securities.
The rapid growth of stablecoins
Stablecoins have grown into a $150 billion market, according to Forbes, and may be the economy’s best shot at a full-scale conversion to digital payments, both in the U.S. and abroad.
Fintechs Tether and Circle have cornered the stablecoin market, carving out a 90% share in the first few years, but new entrants to the sector – including PayPal – are starting to launch their own stablecoins. Currently, Tether issues the most common stablecoin.
Ripple announced in April that it would begin offering its own dollar-based digital currency product in the US with possible expansion into Europe and Asia. As stablecoins continue to grow in market share, considering the importance of stablecoin regulation, stablecoins are becoming crucial, reflecting the increasing scrutiny and calls for tighter regulation by regulators and politicians.
Stablecoins vs. central bank digital currencies (CBDCs)
The conversation around stablecoins often includes another innovation with a similar goal, central bank digital currencies (CBDCs). So what is the difference?
While stablecoins are digital assets issued by private companies – such as stablecoin issuers such as Ripple mentioned above, CBDCs are issued by central banks.
CBDCs aim to digitize the fiat currency of a country and promote more streamlined transactions for citizens. They also bring digital assets directly into monetary policy and can build on the trust of governing bodies rather than private companies, including more visibility into central banks’ decisions.
According to Atlantic Council research, more than 100 countries are researching, developing or currently piloting CBDCs. While CBDCs can work to improve domestic payments, there are still looming challenges around interoperability and their use for international transactions.
More Stable Coins, Better Business Transactions?
As the stablecoin market sees rapid growth and diversifies with healthy competition, the more acceptable they will become across many countries in the global market, including those with weak currencies where stablecoins can serve as a dollar substitute. This trend is poised to transform cross-border payments in many key areas, potentially lowering barriers to dollarization, making foreign currency storage easier and foreign currency transactions easier. This could pose risks to the stability of weak currencies and their policy frameworks, highlighting the significant economic implications of stablecoin adoption.
Speed
With traditional bank transfers or remittance services taking days (or more in the case of cross-border payments using multiple intermediary banks) to process, stablecoin transactions are executed on blockchain networks, enabling near-instant settlements at all hours of the day.
This can eliminate processing delays associated with traditional banking hours and time zones.
Cost effectiveness
Cross-border transactions often have hefty fees associated with manual conversions, banking and processing. These costs can eat into the amount transferred, especially for smaller transactions.
Stablecoins bypass many of these intermediaries and their associated fees as transactions occur directly between the sender and receiver on decentralized blockchain networks.
As a result, stablecoin transactions are typically more cost-effective compared to traditional methods.
Transparency and security
Blockchain technology that underpins stablecoins offers unparalleled transparency and security, which is essential for effective anti-money laundering (AML) measures. Every transaction is recorded on a public ledger, providing an immutable and transparent record of all transactions. This transparency not only reduces the risk of fraud, but also increases trust between transaction parties and significantly contributes to the enforcement of AML regulations by enabling better monitoring of transactions for suspicious activity.
Additionally, blockchain-based transactions are secured using cryptographic techniques, making them highly resistant to tampering and unauthorized access. This level of security is essential to prevent the misuse of digital currencies for money laundering and other illegal activities, further emphasizing the role of blockchain technology in strengthening anti-money laundering efforts in the financial sector.
Accessibility
Stablecoins have the potential to improve financial inclusion by providing access to digital assets and financial services for individuals and businesses in underserved regions.
Unlike traditional banking systems that require extensive documentation and infrastructure, stablecoins can be accessed using only a smartphone and an internet connection.
This accessibility empowers individuals and businesses in remote areas to participate in the global economy, facilitating economic growth and development.
Stability
Arguably the most important feature of Stablecoins is their ability to live up to their name and inject stability into the wider financial system that many still worry about.
The stable nature of a USD-linked token is particularly beneficial for FX payments, where exchange rate fluctuations can lead to significant losses or delays.
By tying their value to a stable reference asset such as fiat currencies, stablecoins reduce the risk of value fluctuations, providing certainty to both senders and receivers in cross-border transactions, while automating conversions and compliance matters via the blockchain.
Programmability
Many stablecoins are built on blockchain platforms that support smart contracts, which support programmable functionality and automation. This type of programmability allows developers to create innovative financial applications and services, such as decentralized exchanges (DEXs), lending platforms and yield farming protocols – and stablecoins are the foundation.
Overall, programmable features unlock new possibilities for decentralized finance (DeFi) and improve the usability of stablecoins within the broader ecosystem.
Understanding stablecoin structures
As the US Federal Reserve noted recently, there are still risks inherent in the stablecoin structure, which at times has caused the tokens to “decouple” from the US dollar – undermining the main stablecoin value proposition. This occurred in secondary markets during periods of monetary stress, particularly during the Silicon Valley Bank crisis. Additionally, policymakers are increasingly concerned about the impact of stablecoins on national monetary policy and the potential for these digital assets to challenge the monetary sovereignty of countries as they can bypass traditional financial systems and controls.
This means stablecoin regulation needs to be further explored as these new technologies develop.
The types of stablecoins that carry the most risk are those that are structured without the direct backing of a cash or cash-equivalent reserve asset. There are three general types of structures:
Fiat-collateralized stablecoins
Generally considered the most effective structure, fiat-backed stablecoins are backed by reserves of fiat currency held in bank accounts. Each stablecoin issued is backed by an equivalent amount of fiat currency, ensuring financial stability.
Crypto-guaranteed stablecoins
Stablecoins with crypto-backed coins are backed by reserves of other cryptocurrencies. These stablecoins are tied to a specific value, such as the US dollar, and are backed by a reserve of other cryptocurrencies, often more volatile and popular cryptocurrencies such as Ethereum or Bitcoin. In this case, a reserve asset serves as collateral to ensure the stability of the stablecoin’s value.
Algorithmic Stable Coins
These stablecoins use algorithms to dynamically adjust the coin’s supply in response to market demand, with the goal of maintaining a stable value without the need for collateral. This means that an algorithmic stablecoin is also dependent on independent investors, which can introduce other forms of risk.
The future prospects for stablecoins
While stablecoins offer compelling benefits for FX payments, several challenges remain, including regulatory uncertainty, scalability issues and the need for interoperability between fintechs and the broader financial system.
However, as blockchain technology matures and regulatory frameworks evolve, stablecoins – and stablecoin regulation – are poised to see rapid growth and play an increasingly important role in shaping the future of digital assets and cross-border payments.
They represent a promising solution to the inefficiencies that plague traditional cross-border payment systems. By offering speed, cost-effectiveness, transparency, accessibility and price stability, stablecoins have the potential to democratize access to financial services and drive global economic growth.
As adoption continues to grow and innovation flourishes alongside popular cryptocurrencies, stablecoins will become a cornerstone of the digital economy, changing the way we trade FX for years to come.
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