Op-ed: Stablecoin is the future of virtual payments. How wise regulation can foster its growth

Key points

  • Today, virtual payments – for instance, using credit cards and payment processing services – require middlemen to facilitate the transaction. This can be costly and slow.
  • Bitcoin paved the way for a virtual payment network with similar properties to cash. There are no gatekeepers controlling the network.
  • Stablecoins, which have a value pegged to an underlying asset, are transferable like cash and can disrupt the virtual payments space.

So far, all stablecoins have been issued by private parties. Inspired by the advances of private players in the field, including Facebook’s interest in launching its Libra coin (now called Diem), central banks have started accelerating their own stablecoin initiatives, with two-thirds of the largest central banks currently experimenting in the field. The core difference between central bank backed digital currencies (CBDC) and privately issued stablecoins is that the former presents a direct claim against the central bank, while the latter are a claim against the issuer. CBDCs are therefore considered a safer option.

But there is a problem with central bank digital currencies. Not only are they safer than other stablecoins, but they are also likely to be perceived as safer than any bank deposits. Why hold money at a bank, which can always run out of money, when you can hold it at the facility in control of the money itself? That can quickly put the whole banking system at risk.

It seems likely that CBDCs will only be made available in limited quantities to the public, creating “space” for privately issued stablecoins, which are able to solve a lot of the problems in payments today. Public blockchains are open, allowing everyone to participate in the system. They facilitate near instant settlement of payment and, with liquid stablecoin markets, swapping between different stablecoins becomes almost frictionless.

Approaching the benefits of cash 

Private stablecoins allow payers to get as close to the benefits of cash as possible. As such, it is no surprise that the global demand for these has grown from $28 billion issued at the beginning of 2021 to $109 billion issued today, an almost four-times increase in just six months.

The first stablecoin, Tether, grew out of the need for cryptocurrency exchanges to hold balances in U.S. dollars while having trouble obtaining a bank account. As such, Tether is still used to facilitate cryptocurrency trading. Tether remains an obscure coin with uncertainty about full backing, which has led to a range of alternative stablecoins hitting the market. Several coins aim to bring more transparency into the segment, with the most popular being USD Coin, which is issued by the Centre, co-founded by Circle and Coinbase.

With the growing amount of stablecoins in the market, the use cases keep growing. As users recognize the cash-like features of stablecoins, payments via this medium increase. In May alone, $766 billion worth of stablecoins were transferred via public blockchains, highlighting sizeable transaction activity. This is especially relevant in the decentralized finance segment, where stablecoins play an important role to enable the ecosystem.

Mainstream applications with stablecoins are also picking up in payments, where they are being used to facilitate cross-border trade and remittances, two areas overburdened with fees by the legacy payment system (migrants pay up to 10% per transaction). It is not just cross-border transactions that are ripe to be disrupted; credit card transactions cost merchants 2% to 3%, which largely end up at the issuing bank, which charges excessive fees. A world in which stablecoins are used instead is not hard to imagine – the savings to merchants especially, but also consumers, would be enormous.

Seeking balance in regulation

The growing interest in the space is attracting regulatory scrutiny, with the main worries being centered around anti-money laundering and “know your customer” risks and financial stability. Regulators used to the closed payment networks are worried about losing control in public networks offered by blockchains. Additionally, they are nervous about any concentration risks within the space, for example, if certain stablecoin issuers become too big.

A range of regulatory bodies have started publishing guidelines, from the Financial Action Task Force to the Bank for International Settlements. While no regulatory measures have been introduced yet, it is only a question of time. Regulators will likely try to ensure that the fiat currency backing the coins is safeguarded, potentially even kept with central banks if the system gets big enough. On top of that, they will potentially try to push for barriers to reduce money laundering. These could take different degrees of severity, from only allowing transfers between approved wallets to investigating payments above certain thresholds.

The stablecoin industry must work together with the regulators to come up with a framework that helps put them at ease while protecting this nascent industry from overregulation. If the industry manages to preserve the openness and cash-like features, stablecoins can alter the way digital payments flow. A world in which digital payments are frictionless and instantaneous is not too hard to imagine, thanks to stablecoins on public blockchains.

New ways of paying become possible, from micropayments to conditional payments, such as escrow. Stablecoins will not only affect how we conduct traditional payments like remittances but will also enable new forms of commerce previously unimaginable. Stablecoins could become the core building blocks of our future financial architecture.

How different regulatory regimes respond to stablecoins, and how far they welcome them, may therefore determine the competitive landscape within financial services for the next 30 years. It seems likely that China, and possibly also the EU, will seek to keep quasi monopoly control of the digital currency through the central bank. China hasn’t allowed privately issued stablecoins on public blockchains and is focused on launch of its central bank digital currency e-CNY.

To the extent that the U.S. and the U.K. allow the private sector to lead on the evolution of the system through private stablecoins, they can forge a different, more flexible and more “liberal” path. Such a path would secure the lion’s share of the innovation and entrepreneurialism that will be the hallmark of stablecoins. It would also enable these economies to win the race toward financial digitization.

Source: CNBC