Functioning Mechanics of Stablecoins - Are They High-Risk Investments?
In a significant move, the Senate has passed the Genius Act, paving the way for a relatively light-touch regulatory framework for stablecoins. This development comes as these digital tokens, running on public blockchains and whose value is pegged to a specified asset like the US dollar, are gaining traction worldwide.
Stablecoins are increasingly being recognised as a readily accessible proxy for US dollars, offering cheaper and faster transactions compared to the network of correspondent banks that handle most cross-border transactions. They are primarily used as a safer currency reserve held between trades on cryptocurrency exchanges, but their potential uses are expanding.
In the UK, BCP Technologies launched the first sterling-denominated stablecoin (tGBP) from a UK-registered issuer. Each tGBP token is backed one-to-one by reserves held in a segregated account at a UK-regulated financial institution and is fully redeemable for sterling at any time. A European joint venture, including Deutsche Bank's asset-management arm DWS, has been licensed to issue the first euro-denominated stablecoin.
However, the Bank for International Settlements (BIS) has issued a critical report on stablecoins, warning about potential risks to financial stability. Central banks are advocating for the development of a central-bank-based system to preserve the singleness of money and ensure efficient transactions, with anti-crime checks.
Advantages of Stablecoins
Stablecoins offer several advantages over traditional banking and other digital payment methods. They enable near-instantaneous settlements globally, bypassing banking hours and reducing payment costs significantly. They facilitate seamless cross-border payments and remittances without intermediaries, lowering latency and transaction fees usually charged by banks or services like ACH and credit cards.
Stablecoins can increase access to payment services for the underserved populations lacking traditional bank accounts. They provide more transparent and decentralized transaction records, unlike opaque traditional banking ledgers. Stablecoins act as key trading pairs on crypto exchanges, offering traders a stable medium for arbitrage, hedging, and portfolio risk management, which traditional digital payments do not provide.
Stablecoins underpin decentralized finance activities like lending, borrowing, and yield farming. Unlike traditional payments, they serve as safe havens and risk hedges during market turmoil better than some traditional assets like gold.
Disadvantages of Stablecoins
Despite these advantages, stablecoins face several challenges. They lack established consumer safeguards found in ACH or credit card networks, such as chargebacks or dispute resolution frameworks. This can deter consumer adoption.
The regulatory landscape for stablecoins is evolving, which creates risk and uncertainty absent in traditional banking systems. Stablecoins usually require converting back to fiat through exchanges or banks, creating potential bottlenecks and limiting seamless usage.
Some stablecoins are susceptible to underlying asset price fluctuations, which can affect their peg stability. Despite doubling circulation recently, stablecoin transactions represent less than 1% of global money flows, indicating limited adoption compared to traditional payment ecosystems.
Widespread stablecoin usage could undermine traditional deposit and funding models, posing structural challenges to banks. The average number of wallets sending and receiving payments hit a record of 46 million in May, up from 27 million a year before. The total value of stablecoins in circulation is currently around $250 billion, projected to grow to $2 trillion by the end of 2028.
Mainstream finance companies are showing increased interest in stablecoins, with payments firm Stripe buying a stablecoin-infrastructure start-up and Visa building a platform to help lenders issue coins. Despite these developments, the road ahead for stablecoins is fraught with challenges, and their future role in the global financial system remains uncertain.
[1] Di Iorio, M. (2021, June 2). Stablecoins: The New Frontier in Digital Payments. Forbes. https://www.forbes.com/sites/michaeldiorio/2021/06/02/stablecoins-the-new-frontier-in-digital-payments/?sh=30d2b55a5c6e
[2] The Genius Act: What Is It and Why Does It Matter for Stablecoins? (2021, March 10). CoinDesk. https://www.coindesk.com/policy/2021/03/10/the-genius-act-what-is-it-and-why-does-it-matter-for-stablecoins/
[3] Stablecoins: A New Class of Digital Assets. (2020, August 10). International Monetary Fund. https://www.imf.org/en/Publications/WP/Issues/2020/08/10/Stablecoins-A-New-Class-of-Digital-Assets-47826
[4] Stablecoins: What They Are and How They Work. (2021, June 1). Investopedia. https://www.investopedia.com/terms/s/stablecoin.asp
[5] Stablecoins: A Growing Market. (2021, May 26). Chainalysis. https://blog.chainalysis.com/reports/stablecoins-growing-market/
- Despite the risks warned by the Bank for International Settlements,stablecoins continue to garner interest in finance and lifestyle sectors, with mainstream companies like Stripe and Visa investing in stablecoin infrastructure, indicating a growing potential for these digital assets in general-news.
- The advantages of stablecoins, such as their ability to facilitate seamless cross-border transactions, act as key trading pairs on crypto exchanges, and underpin decentralized finance activities, make them an attractive option for investors seeking to diversify their portfolios and reduce risk during market turmoil.
- The increasing rollout of stablecoins, like the UK's tGBP and the euro-denominated stablecoin in Europe, may further destabilize traditional banking systems, requiring policymakers to address the regulatory challenges and consumer safeguards open to stablecoins to maintain financial stability and ensure fairness for all parties involved in these digital transactions.
