It is easy to see why stablecoins have gained appeal – especially for the traditional financial industry. In a world that relies on a successful global economy, access to affordable and efficient methods of payments and fund transfers is essential.
The current situation, however, means that cross-border payments are slow, expensive, and opaque. All in all; they are in dire need of a facelift. And many envision stablecoins and cryptocurrencies as the solution to many of these financial challenges.
The cost and lag of financial transactions is not only a problem for large companies, but more importantly, it is a problem for individuals. Not only are transactions prohibitive and costly, but estimations of unbanked adults range around 2 billion! That means that nearly one-quarter of the entire world’s population has limited or no access to the tools necessary to participate in the economy.
Bitcoin was the first successful digital currency in 2008 and has since created a strong counter-cultural movement in the world of economics and fintech. Unsurprisingly, the greater population is catching on to the benefits of digital currencies. However, one of the major concerns that face all cryptocurrency users is the volatility, longevity, and scalability of the technology.
As cryptocurrencies become more appealing to the traditional financial world, banks and companies look for ways to make digital coins work for them. For many financial institutions, this means using stablecoins to improve services.
Why Go Digital
Stablecoins are one way that cryptocurrencies attempt to solve issues such as volatility and liquidity. Stablecoins attempt to stabilize cryptocurrencies by linking the token or coin to a pool of physical assets.
Cryptocurrencies are non-fiat currencies, such as Bitcoin. That means, rather than have the value of Bitcoin dependent on a country’s wealth and stability, or the value of a piece of real estate, Bitcoin’s value is based purely on the market value.
There are many benefits to using non-fiat cryptocurrencies, such as Bitcoin, particularly if you live and work in a country with an unstable currency. However, as mentioned, this often means that the token’s value suffers from volatility, as is the case with Bitcoin.
By tying the value of a cryptocurrency to a pool of assets, such as precious metals, or real estate, for example, it creates a kind of hybrid token. Stablecoins tend to use blockchain, which is the same technology that Bitcoin operated on. However, unlike Bitcoin, the value of a stablecoin is linked to assets, products, or the success of a given project. That means that the coin has the security and efficiency of digital currency. However, it is far more “stable” because it is tied to a collection of assets.
A popular example of a stablecoin is Facebook’s Libra. Libra is also a cryptocurrency. However, it is backed by a basket of securities and fiat currencies. Libra is backed by the US dollar, the euro, the pound, and the yen. Given that these are stable currencies, Libra’s value should remain stable as well.
How Digital Currencies Work
The primary function of stablecoins and cryptocurrencies are:
- Payment Services
Essentially, stablecoins solve two problems, firs off, large as well as cross-border transactions are time-consuming and costly. And, when it comes to global transactions multiple entities are involved so that payments can change hands. Stablecoins use the technology of cryptocurrencies, which relies primarily on blockchain technology. This means that transactions are electronic and safe, AND within the same day.
Essentially, stablecoins solve two problems, firs off, large as well as cross-border transactions are time-consuming and costly. And, when it comes to global transactions more and more entities are involved as payments change hands. Stablecoins use the technology of cryptocurrencies, which relies primarily on blockchain technology. This means that transactions are made electronically and safely, AND within the same day.
Blockchain In Brief
Blockchain technology is the technological core of most digital currencies, such as Bitcoin, and is likewise used for the foundation of many stablecoins. The way that digital currencies work is as cryptographic blocks of data. These data blocks hold the information of each transaction within them. The information is then stored on distributed networks around the world.
That means that information about each transaction is not stored or controlled in one location. Transactions are stored among multiple networks. This means that there are multiple backups, as well as multiple confirmation processes so that the data is carefully approved and correctly maintained.
The blockchain itself functions as a cryptographic ledger, that can be publically run and fully distributed. It can also be privately organized and centralized, or it can be a hybrid of both. Bitcoin, for example, is totally decentralized and distributed; there is no ONE Bitcoin network, it functions on distributed nodes.
However, this is where stablecoins can use a combination of the distributed networks, with a more centralized organization. The centralization would be the assets that back the coins, as these are managed by companies and financial institutions.
Another reason that blockchain improves financial efficiency and security is that it offers a fully automated system. That means that transactions operate with code and automated “smart-contracts.” Smart-contracts are programs that are only deployed once all of the criteria have been met.
Models of Stablecoins
As I mentioned, stablecoins are a hybrid model of cryptocurrency; they use the same technology but have a specified source of value.
Here are a few models of stablecoins:
- Face value: these coins represent a unit, either in a company or a project, and can then be used for transactions.
- Direct claim on the asset: in this case, the users have a direct claim from the issuer of the coin, or on the assets that are the foundational value.
- Pledges: the purchase of some types of stablecoins can be a pledge to the company to be redeemed at a later time for the amount is was purchased; ideally for more than the original purchase price.
- Shares: the coin can be a share in the underlying value of the assets, which is similar to ETFs.
- Public Trust: this kind of coin is more like Bitcoin, where the value is based on the usability and value amongst users.
Stablecoin Projects and Risks
There is a myriad of stablecoin projects in the works in 2020, and many got the ball rolling in 2019. Given the enthusiasm for stablecoins in the financial services industry, it has sparked some concerns for the traditional financial world as well as policymakers.
The estimated number of stablecoins currently on the market is around 150, popular stablecoins are those such as Tether and Libra. However, be prepared for an increase in stablecoins in 2020, including centralized and fiat-currencies. This comes on the heels of COVID-19, and the rush to improve the digitization of financial transactions.
Concerns and questions regarding the technology have to lead to a comprehensive risk assessment from the G7 Working Group, regarding stablecoins.
First, we will look at several promising stablecoin projects. Following that, we turn to a distillation of the concerns that the G7 Working Group has addressed in their report regarding stablecoins.
Profiles of Coin Projects for 2020
State Street Corporation (NYSE: STT) is one of the world’s leading providers of financial services. In 2019, they officially launched a partnership with the cryptocurrency company Gemini. State Street works with institutional investors to provide investment servicing, investment management, and research, as well as trading projects.
Based on an official report from State Street, as of September 2019, the company holds $32.90 trillion in assets under custody and administration, as well as $2.95 trillion in assets under management. The operation has a global outreach of more than 100 geographic markets while employing nearly 40,000 people worldwide.
Gemini Trust Company
Gemini was founded in 2014, by twin brothers Cameron and Tyler Winklevoss. They want to harness the technology of blockchain and cryptocurrency for the greater financial industry. State Street has decided to partner with Gemini Trust Company, LLC (Gemini). Currently, Gemini operates as a cryptocurrency exchange and custodian. Gemini allows customers to buy, sell, and store cryptocurrencies such as Bitcoin.
They are a New York-based trust company, and as such, they are subject to the capital reserve requirements, cybersecurity requirements, as well as banking compliance standards set by the New York State Department of Financial Services and the New York Banking Law.
“We want to evolve our business with our clients’ needs. The digital asset space is still nascent, yet it promises opportunities that could fundamentally impact how we do things in the future. There is small, but growing demand from our clients for solutions of this type and many technical, operational, regulatory, and legal considerations to be addressed. That is why we have opted for an open model, and started a pilot with Gemini as an established, regulated player in the digital asset space.”
-says Ralph Achkar, managing director, Digital Product Development & Innovation at State Street.
WisdomTree has subsidiaries in the U.S., Europe, and Canada and is an exchange-traded fund and exchange-traded product sponsor and asset manager. Currently, WisdomTree offers products for equities, fixed income, currencies, and commodities. The current approximated value of assets is $63.8 billion in management globally, which underlie the stablecoin project.
In January of this year, 2020, WisdomTree Investment Inc. announced that they have launched an exchange-traded fund (ETF) and exchange-traded product (ETP). Securrency, Inc. is strategically involved in the project’s investment.
The coordinated effort between WisdomTree and Securrency will integrate blockchain into the exchange-traded funds. This is a relatively new direction, as WisdomTree began with mutual funds. They have since decided that stablecoins will add to the services that they can offer their customers.
IBM in partnership with several international banks
In March 2019, IBM announced the launch of its global payment blockchain network World Wire. This new blockchain project will partner with a handful of banks and financial services to provide stablecoins on the IBM blockchain network.
Presently, the tech giant has signed partnerships with Banco Bradesco, Bank Busan, and Rizal Commercial Banking Corporation. This partnership will mean that IBM’s blockchain will now offer payment solutions for 72 countries with 44 banking endpoints.
The focus of the blockchain project is to optimize and accelerate foreign exchange, cross border payments as well as remittances. The protocol used is Stellar, therefore, World Wire can serve as a network provider for international payments. This means faster point-to-point money transfers. This will improve on the current system, which is rife with complexities and delays.
Central Bank of Russia
Russian is one of several countries that is testing the use of stablecoins in a centralized program. It is unclear how the country will use stablecoins, however, they are currently working on test cases. A primary concern is how stablecoins would be regulated by the Bank of Russia.
Elvira Nabiullina, Russia’s central bank head, said:
“We are testing stablecoins in our regulatory ‘sandbox’. We see companies willing to issue tokens pegged to certain real assets. In our regulatory sandbox, we are learning the potential uses of stablecoins but we do not assume that they will function as a means of payment and become a surrogate for money .”
With that in mind, it will be interesting to see how the Bank of Russia decides to use stablecoins, and if they will work on a blockchain platform. At present, it seems as though the country is primarily interested in understanding the technology. They want to see how stablecoins can be used for their centralized benefit.
One report states that the Bank of Russia wants to explore central bank digital currency (CBDC). In theory, this would mean the BOR would have its own digital currency -the digital ruble. They are currently studying the effects and use cases of other jurisdictions before they make any further statements about if and how the digital currency would work.
Central Bank of France
In a similar project to that of Russia’s, the Central Bank of France is working on a digital euro. This is set to begin this year, 2020. The governor of the Bank of France, François Villeroy de Galhau, announced that the bank will start testing by the end of the first quarter of 2020.
The coin is a fiat-digital currency. That means it will be a digital euro. However, it does not mean that the CBOF plans for the token to get used in the same way as the euro. The digital euro is focused on the private financial sector. However, does not have current plans for retail use and individual payments.
France is concerned with improving the efficiency of France’s financial system by developing digital currencies that serve their purposes. France is interested in the digital currency because it is concerned about projects such as Facebook’s Libra. It is evident that digital currencies are a part of a healthy financial future. Despite this fact, currently, most projects are private. Stablecoin’s give centralized currencies a chance to participate in the utility of digital currencies.
China’s Digital Yuan
While France and Russia are in the pilot phases of their digital coin projects, China plans to become the first major central bank to issue its own currency. The People’s Bank of China will issue a digital version of the yuan.
China’s stablecoin will not, however, have much in common with cryptocurrencies. This coin is a fully centralized fiat-coin, and it is unlikely it will even run on a blockchain platform. Presently, most of China’s financial transactions are digital, and the PBOC plans to maintain its central control of an economy that is rapidly becoming digital.
China already has commercial banks as well as Big Tech companies such as Ant Financial and Tencent Holdings Ltd., that offer digital payment services. However, the PBOC is concerned with centralized management of cryptocurrency tech.
Although this will be a digital yuan, the PBOC does not believe that blockchain has the scalable capacity to support the demand of the large volume of Chinese transactions. China’s digital transaction demands are well beyond the capacity of any functioning blockchain to date. On China’s annual Singles’ Day shopping gala in 2018, payments peaked at 92,771 transactions per second.
Stablecoins pose legal, regulatory, and oversight challenges and risks related to the following financial institutions:
- Legal certainty
- Sound governance, including the investment rules of the stability mechanism
- Money laundering, terrorist financing and other forms of illicit finance
- Safety, efficiency, and integrity of payment systems
- Cybersecurity and operational resilience
- Market integrity
- Data privacy, protection, and portability
- Consumer/investor protection
- Tax compliance
A Closer Look at Some of the Limitations: G7 Working Group
The G7 Working Group, International Monetary Fund, and the Bank of International Settlements has released an investigation and report on stablecoins. Although the report recognizes the potential and value of stablecoins, it primarily highlights the concerns there are for how disruptive cryptocurrencies and stablecoins are to the traditional financial system.
The primary concerns that came out of the investigation were based around governance; who is responsible for how stablecoins are used, and who is liable for their failures? These are important problems to consider from both a financial and technological perspective. While the technology is robust and the need for digital currencies is obvious, managing risk on a large scale remains a real issue.
For example, regulatory authorities such as centralized banks should strive to keep inflation low and maintain monetary stability. Moreover, regulatory authorities and banking utilities, such as the Bank For International Settlements, implement rules, banking requirements, and providing users with services. They also ensure financial institutions comply with the necessary jurisdictional law.
While such groups exist to maintain a healthy economy, historically, they are reactionary to surprise events. Such failures and reactions are demonstrated with Black Tuesday (October 29, 1929). This marked the start of the Great Depression. The result was the Glass-Steagal Act of 1932, which implemented legislation to protect consumers and structure the banking industry.
More recently is the example of the Financial Crisis (Great Recession) of 2007 – 2008. This crisis was caused by unsustainable investment in mortgage-backed securities and collateralized debt obligations. It led to the creation of the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010.
The main conclusion from the report is that based on the risks to financial health, clear and robust policies must be put in place. One major hurdle is to fully understand the structure of the technology, as well as the greater potential for the economic impact on a global scale.
2020 – The Future of the Global Economy
With stablecoin projects in the works from centralized banks and private companies alike, we can surely brace ourselves to see the burgeoning of digital coin projects. Stablecoins, like cryptocurrencies, offers massive potential to improve the speed of cross-border payments, to reduce transaction costs, and to increase access to financial products for the nearly 2 billion people currently without bank accounts.
There are certain risks that will require a continued attention, such as governance and responsibility, AML and terrorist activities, the security of cyber payment systems, privacy, and data protection, as well as taxation schemes. The new market of stablecoins could include underserved entrants like farmers, migrant workers, and other types of micropayments typically paid in cash.
Stablecoins have the potential to threaten and change monetary policy, financial stability, international monetary systems, and fair competition. While there are many potential benefits, there is still a learning curve for users and suppliers that needs to be acknowledged.
Public authorities need to move towards embracing this technology so that it can be developed in a wider testing field. Governments should, therefore, prepare themselves by organizing guidance for use, including the necessary principles and standards of a stablecoin.
Despite the risks that stablecoins pose to the current state of the financial industry, digital currencies have great potential to improve financial activities on a global scale. Digital currencies are able to be transacted faster and cheaper than typical transactions. This means there is great potential for more reliable, less costly payment systems that are able to improve financial inclusion.
Stablecoins offer an excellent ecosystem for combining the technology of cryptocurrencies with the stability of physical assets. By backing digital tokens with real assets there is great potential to see the stabilization of cryptocurrencies, which tend to be volatile assets. Moreover, by stabilizing the value of digital currencies, we are more likely to see the steady improvement of scalability as more companies and governments move into testing their applicability.
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