Cryptocurrency has been in the sights of the payments industry for more than a decade, but it still only just making its way into mainstream commerce.
One reason is volatility — the value of cryptocurrency is often driven by untamed speculation.
Crypto investors have become millionaires overnight, only to lose much of their wealth just weeks later. While this can be exciting to witness, it also shows the unreliable nature of popular cryptocurrencies like bitcoin — especially as a means for paying for goods and services.
This is where stablecoins come into play.
Stablecoins are designed to have a value that is fixed because they are pegged to other assets, such as the US dollar or gold.
The vision is that stablecoins can enjoy the benefits of being a cryptocurrency without the associated extreme volatility — this would go a long way to helping cryptocurrencies be seen as a viable way to actually buy something.
After all, most businesses aren’t interested in accepting a form of payment that might drastically reduce in value the next day. If traditional crypto is like investing in a high-risk stock, stablecoins are like withdrawing cash from an ATM.
And stablecoin demand is surging: From October 2020 to October 2021, the total value of stablecoin assets grew by roughly 495%, according to The Block.
This reflects the momentum driving the so-called “stablecoin invasion.”
There are now more than 200 stablecoins globally, comprising a market that’s worth nearly $130 billion. Additionally, two USD-backed stablecoins, the Paxos Standard (PAX) and Gemini Dollar (GUSD), have been approved and regulated by the New York State Department of Financial Services.
Financial services incumbents are also eyeing the opportunity — JPMorgan Chase, for example, has piloted and launched a stablecoin, JPM Coin, for its corporate clients.
Meanwhile, a survey of central banks in January 2021 found that two-thirds of respondents are actively researching the potential impact of stablecoins on financial stability.
And yet — despite being the purported answer to cryptocurrencies’ volatility — stablecoins are now under close scrutiny, with regulators in the US and China saying they pose a serious risk to financial systems.
Why use stablecoins?
As mentioned, stablecoins are not subject to the extreme price volatility that many other cryptocurrencies are affected by.
In 2010, for example, a programmer purchased pizza for 10,000 bitcoins — worth roughly $688 million at bitcoin’s peak in November 2021. On the flip side, any merchant that accepted those bitcoins at that peak price would have lost more than $200 million by the end of the year.
As a result, many businesses are sceptical of crypto as a viable means of payment. Microsoft, for example, first started accepting bitcoin as a payment in 2014, only to put a temporary halt on it in 2018 due to volatility. Online gaming platform Steam was forced to do the same.
Stablecoins, on the other hand, aim to gain the potential benefits of cryptocurrencies — such as transparency, security, immutability, and decentralised control — without losing the guarantees and stability that come with using fiat currency.
Initially, early crypto holders used stablecoins as a safe haven in the event of a market decline or crash. If the price of bitcoin began to drop rapidly, a holder could convert their bitcoin to a stablecoin within a matter of minutes on a single platform, avoiding potentially massive losses.
Without this option, the crypto holder would have had to move their capital back into a fiat currency. However, many cryptocurrency exchanges either do not allow fiat on the platform or take a large fee from the transfer into fiat.
But stablecoins are showing promise in other emerging applications. For example, they could benefit industries and individuals that need to make international payments quickly and securely, from migrant workers sending money back to their families to big businesses looking for a cheaper way to pay overseas suppliers.
Stablecoins could also find uses across the financial services ecosystem.
For decentralised cross-border lending, for example, stablecoins could help provide a secure, online environment for peer-to-peer (P2P) transactions to take place without needing to use a volatile cryptocurrency like bitcoin or pay fees to convert money into local currencies.
Risks and regulations
A recent US Treasury report on stablecoins discussed the systemic risk that a single coin could pose if it becomes widely adopted. The risk is especially high with centralised coins, such as those backed by fiat and issued by private organisations, as economic power would be disproportionately concentrated on a single entity.
Tether is among the more likely coins to present such a risk, given its current market share of more than 50%. If Tether fails, it could undermine an entire ecosystem of apps, businesses, and consumers that use it.
If the economy overheats and the value of Tether’s non-cash collateral plummets, investors might try to cash out their stablecoins, only to find that the issuer can’t give them back their money on a 1:1 ratio. This scenario could destabilise not just the crypto market, but also the wider financial system.
The widespread use of stablecoins in payment platforms also presents a systemic risk, according to the same report.
The novel operational risks tied to the validation and confirmation of stablecoin transactions can interfere with payment systems. If millions of users can’t access money in their e-wallets and businesses can’t receive payments, economic activity would be greatly disrupted.
The road ahead
While it is impossible to predict what the future has in store in the constantly changing world of blockchain, stablecoins could help bring cryptocurrencies further into the mainstream.
Already, financial services players — from bank incumbent JPMorgan to payments network Visa — are giving nods to stablecoin technology through partnerships and internal R&D. Further, stablecoins are making inroads with regulatory bodies.
Each form of stablecoin comes with its own unique set of benefits and drawbacks, and none of them are perfect.
Yet the value and stability they could provide to businesses and individuals globally — by enabling better access to established national currencies, streamlining payments and remittances, and supporting emerging financial applications — could be disruptive.
Widespread adoption of digital currencies more broadly will depend on whether or not crypto can find a role for everyday users and use cases. Stablecoins, we feel, are a clear step toward this.
To read the full CB Insights Report CLICK HERE
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