As the cross-border payment landscape changes and digital currency exchanges evolve for more practical usage by the day, one of the main hurdles to solve has long been the stability of popular cryptocurrencies and digital assets.
The speculative trading of assets such as Bitcoin or Ethereum have triggered volatile swings in their value and sewed doubt into the minds of mainstream businesses that could otherwise benefit from a blockchain-based payments systems.
One of the main issues has been that these speculative cryptocurrencies are not pegged to the US dollar.
Enter stablecoins, a blockchain-based token that can be tied to hard dollars on a one-for-one ratio redeemable by an issuer, who typically holds reserve assets in cash or investment-grade securities.
The rapid growth of stablecoins
Stablecoins have grown to a $150 billion market, according to Forbes, and they could be the economy’s best chance at a full-scale conversion to digital payments, both in the US and abroad.
Fintechs Tether and Circle have cornered the stablecoin market, staking out a 90% share in the first few years, but new entrants into the sector — including PayPal — are beginning to launch their own stablecoins. Currently, Tether issues the most popular stablecoin overall.
Ripple announced in April that it will begin offering its own dollar-based digital currency product in the U.S. with possible expansion to Europe and Asia. As stablecoins continue to grow in market share, considering the importance of stablecoin regulation stablecoins become crucial, reflecting the increasing scrutiny and calls for tighter regulation by regulators and politicians.
Stablecoins vs. central bank digital currencies (CBDCs)
The conversation surrounding stablecoins often features another innovation with a similar goal, central bank digital currencies (CBDCs). So what’s the difference?
Whereas stablecoins are digital assets issued by private companies — such as stablecoin issuers like Ripple mentioned above, among others — CBDCs are issued by central banks.
CBDCs aim to digitize the fiat currency of a country and foster 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 research from the Atlantic Council, over 100 countries are either researching, developing, or presently launching CBDCs. Yet while CBDCs may work to enhance domestic payments, there are still looming challenges surrounding interoperability and their use for international transactions.
More stablecoins, 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 marketplace, including those with weak currencies where stablecoins could serve as a dollar substitute. This trend is poised to transform cross-border payments in many key areas, potentially lowering barriers to dollarization, making the storage of foreign currency easier, and facilitating transactions in foreign currency. 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 that use multiple intermediary banks) to process, stablecoin transactions are executed on blockchain networks, enabling near-instantaneous settlements at all hours of the day.
This could eliminate processing delays associated with traditional banking hours and time zones.
Cost-effectiveness
Cross-border transactions often incur hefty fees associated with manual conversions, banking and processing. These costs can eat into the amount being transferred, especially for smaller transactions.
Stablecoins bypass many of these intermediaries and their associated fees since 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 underpinning stablecoins offers unparalleled transparency and security, which are crucial for effective anti-money laundering (AML) measures. Each 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 enhances trust between transacting parties and contributes significantly to the enforcement of AML regulations by allowing for enhanced monitoring of transactions for suspicious activities.
Additionally, blockchain-based transactions are secured using cryptographic techniques, making them highly resistant to tampering and unauthorized access. This level of security is essential in preventing the misuse of digital currencies for money laundering and other illicit 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 just 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
Probably the most important feature of Stablecoins is their ability to live up to their name and inject stability into the broader financial system many still have concerns about.
The steady nature of a USD-pegged token is particularly beneficial for FX payments, where exchange rate fluctuations can result in significant losses or delays.
By pegging their value to a stable reference asset like fiat currencies, stablecoins mitigate the risk of value fluctuations, providing certainty to both senders and receivers in cross-border transactions, while conversions and compliance matters become automated 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 enhance the utility of stablecoins within the broader ecosystem.
Understanding stablecoin structures
As the US Federal Reserve recently noted, there are still risks inherent in the stablecoin structure, which at times have caused the tokens to “de-peg” from the US Dollar — undermining the main stablecoin value proposition. This has occurred in secondary markets during periods of monetary stress, most notably during the Silicon Valley Bank crisis. Moreover, policymakers are increasingly concerned about the impact of stablecoins on national monetary policies and the potential for these digital assets to challenge the monetary sovereignty of countries, as they could circumvent traditional financial systems and controls.
That means stablecoin regulation must be further examined as these new technologies develop.
The types of stablecoins posing the most risk are those structured without direct backing from a cash or cash-equivalent reserve assets. There are three general types of structures:
Fiat-collateralized stablecoins
Generally considered the most effective structure, fiat-collateralized 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-collateralized stablecoins
Crypto-collaterized stablecoins are backed by reserves of other cryptocurrencies. These stablecoins are pegged to a specific value, such as the US dollar, and are backed by a reserve of other cryptocurrencies, often more volatile and popular cryptocurrencies like Ethereum or Bitcoin. In this case, a reserve asset acts as collateral to ensure the stability of the stablecoin’s value.
Algorithmic stablecoins
These stablecoins use algorithms to adjust the coin’s supply dynamically in response to market demand, aiming to maintain a stable value without the need for collateral. That means an algorithmic stablecoin are also reliant on independent investors, which can introduce other forms of risk.
The future outlook 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 continue to see rapid growth and play an increasingly significant role in shaping the future of digital assets and cross-border payments.
They represent a promising solution to the inefficiencies plaguing 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 are set to become a cornerstone of the digital economy, transforming the way we conduct FX transactions for years to come.
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