How stable is Stablecoin, and what does it mean for banks?
By Kaj Burchardi, Managing Director at BCG Platinion
Traditionally, cryptocurrencies have been defined by wild price swings and extreme volatility. But there is one cryptocurrency type that is designed to be the exact opposite.
Stablecoins, as the name suggests, are intended to be stable in price. In short, they are supposed to hold roughly the same value from the day you buy one to the day you spend it or trade it in.
That's because, unlike other cryptocurrencies, the price of most Stablecoins are collateralized to a flat asset, such as the US dollar, or a commodity like gold. This means that they are far less likely to widely fluctuate in value, as the asset they are pinned to doesn’t considerably change. What’s more, Stablecoins can either facilitate payments or be used as a store of value, or both. This makes them a tantalizing proposition for the finance industry, who have long been wary of more volatile cryptocurrencies.
And, as of this October, the combined supply of Stablecoins from the ten biggest issuers was worth $127.8 billion, according to data from The Block, a provider of crypto research and analysis. That's up from $21.6 billion in 2020.
However, Stablecoin-based payments only represent a tiny fraction of the global non-cash payment space (less than 1% in 2021); but this could rapidly change. The rate of transactions using Stablecoin is rapidly increasing, and could begin eating into amount of non-cash payments in the coming years.
But how should banks look to participate on the Stablecoin opportunity, and are there any risks or concerns?
The advantages Stablecoin
Stablecoins have become increasingly popular over the last three years due to the three main advantages they provide: they offer the potential for better integration into digital transactions, designed by firms that thrive on user-centric design; multi-national corporations like JP Morgan and Wells Fargo increasingly view them as a lucrative solution to settle cross-border payments; and they also offer investors and traders a safe haven when markets become volatile.
In fact, banks around the world have already begun taking advantage of Stablecoin. For instance, USD Coin (USDC) is a Stablecoin that is backed by and is pegged to the United States dollar. The issuance and redemption of USDC tokens are powered by the Ethereum blockchain using an ERC-20 token and smart contract. As of September 2021, there are more than 27 billion USDC in circulation.
USDC is used by Bank Frick as a means to settle U.S. dollars transfers, via the transfer of USDC, faster than a transfer of U.S. dollars via the traditional SWIFT network. This means that Bank Frick is able to process transactions faster than other banks, with a stable currency that is comparable to USD, across borders.
But not all Stablecoins are the same, and there are four main categories which are based on the method used to maintain a stable value of the coin. These are:
-
Flat-collateralized
- This is backed by sovereign currency such as the pound or the US dollar
- In order to issue a certain number of tokens of a given cryptocurrency, the issuer must offer dollar reserves worth the same amount as collateral
-
Commodity-collateralized
- This is backed by commodities such as gold
- It is maintained by custodians that function independently and are audited fo
compliance on a regular basis
-
Crypto-collateralized
- The value of this Stablecoin is pegged to that of other cryptocurrencies
- Since the underlying asset, in this case, is also a cryptocurrency, it is not
conventionally safe and may also be highly volatile
-
Non-collateralized
- The value of these depends on a complex combination of algorithms and smart contracts
to keep a stable price, by buying and selling the stable token and manipulating its
supply
- The value of these depends on a complex combination of algorithms and smart contracts
Deploying Stablecoin
Despite the clear benefits that Stablecoin provides, it isn’t yet at a stage where banks are ready to adopt it en-masse. This is because historically many banks have been digital laggards, and need to implement the right technology strategy in order to utilize the currency.
The new technology setup which utilizes Distributed Ledger Technology (DLT) allows a bank to take advantage of Stablecoin.
In the DLT based setup, banks will use a decentralized network that supports direct value exchanges. This requires setting up a network the bank and its payment partners join or joining one of the existing networks. With this 'tokens' can be exchanged amongst participants: Stablecoin, smart contract instructions, etc.
Advantages of using a DLT-based approach include: the network protocol ensures the safe transfer of value; developers can easily leverage this transfer of value by building apps and the network can be permissioned or permissionless, depending on the needs.
Calls for regulation
It’s not all clear sailing for Stablecoins, either. As the cryptocurrency grow in popularity, so do to calls for stricter regulation. Earlier this month, a group of US regulators said legislation is urgently needed on dollar-based Stablecoins and argued that operators of the digital tokens should be treated as banks.
This follows on from another proposal last December, when US legislators proposed the Stable Act which would require Stablecoin operators to obtain full banking licenses.
These moves would bring a drastic increase in supervision for the issuers of Stablecoins, which have so far worked on the fringes of the financial system, subjecting the $130bn industry to strict regulation in return for access to emergency liquidity from regulators in times of stress. The deposits of customers at insured financial institutions are also backstopped by the US government up to a certain dollar amount.
Regardless of whether Stablecoin is heavily regulated in the future, however, it is clear that it provides banks with a promising opportunity to utilize a far more reliable and trustworthy cryptocurrency, and we can expect adoption and growth in payments to continue increasing. Banks would be wise to begin exploring how they can adopt Stablecoin, as cross-border digital payments become more popular.