There are few segments of the cryptocurrency industry that get as much focus from policymakers as stablecoins.
Ever since Meta panicked elected officials, central bankers and financial organizations from the G20 to the Financial Action Task Force by announcing plans in June 2019 to launch a stablecoin that would be instantly available for payments to Facebook’s 2.3 billion users around the planet, the dollar-pegged cryptocurrencies have been in the crosshairs.
To start, let’s be clear about what stablecoins are. The cryptocurrency tokens are intended to hold a steady, one-to-one peg with a fiat currency, the vast majority of them the U.S. dollar. There are two basic ways of doing this. By far the most common is by backing them one-to-one with a cache of dollars or highly liquid investments that would allow the issuers to redeem them on demand. This provides the investor confidence needed to support the fixed price to with a few thousandths or 10 thousandths of a penny.
The second is using decentralized finance, or DeFi, to create algorithmic stablecoins, which use smart contracts to manipulate the price by encouraging arbitragers to buy or sell as necessary to keep the dollar peg.
See also: PYMNTS DeFi Series: What Is an Algorithmic Stablecoin? DAI and the Fiat-Free Dollar Peg
Over the next two days we’re going to look at the stablecoin arguments, looking first at the benefits of privately issued stablecoins and, tomorrow, their potential financial hazards.
The Market Lubricant
So, why are stablecoins a good thing?
Starting at the beginning, stablecoins are the lubricant that makes the cryptocurrency market flow. While traders can make atomic swaps — trading one cryptocurrency directly for another — there are thousands of coins. Unless you’re dealing with very large, very liquid cryptocurrencies and exchanges, it’s often far easier to sell one token for stablecoins and buy another with them. Crypto would, of necessity, be a lot smaller without stablecoins.
Beyond that, for frequent traders, stablecoins are a good way to park funds while waiting for the next buying opportunity. And as exchange trading fees decrease substantially for high-volume traders, the back-and-forth doesn’t cut too far into profits.
For years, Tether’s USDT stablecoin, known as lower-case-t tether, was effectively the only game in town. It’s still the largest — with $84.5 billion USDT in circulation, it’s the third-largest cryptocurrency, after bitcoin and ether. Second place is Circle’s USD Coin, USDC, with a $51.8 billion market capitalization, and then Binance’s USD, issued by the world’s largest exchange. Its market cap is $17.5 billion.
The Most Usable Currency Cryptocurrency
Bitcoin was designed first and foremost to be an alternative currency — a store of value that would empower people to make peer-to-peer payments while bypassing the costly middlemen of the financial industry.
“All of a sudden you can build apps that hundreds of millions of people can interact with,” Jeremy Allaire, CEO of USD Coin-issuer Circle, told PYMNTS’ Karen Webster last summer. “You can move value in milliseconds for a fraction of a penny. And so the breakthroughs that are possible, that people imagined becoming possible, are now arriving.”
And while it’s getting easier to use Bitcoin and a few other cryptocurrencies that way, thanks largely to Mastercard-, Visa-issued debit cards and PayPal’s decision to open its 32 million-plus merchant network to several cryptocurrencies, the volatility of cryptocurrencies makes them difficult to use on a day-to-day basis.
Stablecoins take care of the volatility problem, which can reach 10% in a few hours. You know that you’re spending — or accepting — $5 for a cup of coffee that will be worth $5 tomorrow, not $4.50 or $5.50.
That’s a doubly important issue in places where the economy is in serious trouble, as Venezuelans trying to keep their head above water can’t afford to have their crypto’s value fall 45% in five weeks — which happened in the five weeks between mid-April and late May last year.
The same applies to the remittance market. The cost savings makes sending crypto far better than traditional cross-border payments methods for small sums. But by sending stablecoins, it’s not a crapshoot for people living on the edge.
DeFi’s Alternate Lending Market
Stablecoins are at the core of much of the decentralized finance, or DeFi, industry. One of the main creations of DeFi are the lending markets that let people put up crypto as collateral and borrow stablecoins. The point is to let people pull usable funds from crypto investments they don’t want to cash out.
And while a lot of it is used by crypto and crypto derivatives traders, those funds can be used in any way by borrowers. And lenders can earn interest without going through financial institutions that take a cut off the top.
“You’re seeing the birth of interest rate markets where people can borrow and lend through a machine on the internet,” Allaire said. “And that’s really dramatic. … It opens up access to financial services, potentially, to far more people than have had access before.”
Mucking Out Middlemen
Those same factors arguably make stablecoins a better mousetrap for avoiding the traditional financial middlemen who take a cut out of payments. With financial rails in place for crypto — and barring legal bans, they’re coming — it would be a lot easier to get merchants to accept stablecoin payments.
Which isn’t to say that there would be no new payments rails in a stablecoin-friendly regulatory environment.
They would open the market to innovative solutions from new FinTechs, U.S. Rep. Patrick McHenry, R-N.C., said at the House Financial Services Committee’s hearing on the President’s Working Group on Financial Markets’ stablecoin report in February.
Read more: White House Seeks Stablecoin Regulations
Arguing in favor of a discussion of “the potential benefits of increased use of stablecoins,” McHenry said the “policies we develop must promote private sector innovation, and foster competition to build a resilient product without creating risk.”
Noting that the ability of crypto technology firms to issue stablecoins — which the administration wants to ban, preferring only insured federal banks issue them — led Minnesota Republican Rep. Tom Emmer to argue that banks “should not be the only institutions in the ecosystem with dibs to issue the potential array of financial products that the President’s Working Group report simply lumps together as a stablecoin.”
Protecting the Buck
One of the big anti-stablecoin arguments is that by reducing the need for fiat currency it imperils the dollar’s status as the world’s reserve currency. This is one of the arguments for reining in stablecoins — for example by limiting issuance to FDIC-insured banks, as recommended by the administration’s stablecoin report.
Much the same applies to the argument for a U.S. central bank digital currency (CBDC) — the digital dollar. Particularly as many other countries are investigating or building their own CBDCs.
But there’s another perspective, based on the reality that the vast majority of stablecoins are backed by and thus denominated in dollars.
Related: House Committee Voices Concerns Over Stablecoin’s Effect on Dollar
“I believe stablecoins that are stable, and can deliver a stable value tied to the dollar, would benefit the U.S. dollar,” Nellie Liang, Treasury undersecretary for domestic finance, told the House Financial Services Committee stablecoin hearing in February.
That answer came after Rep. Andy Barr, R-Ky., suggested that stablecoins “would likely not compromise the dollar as the world’s reserve currency” or interfere with digital dollar.
Barr then jumped into CBDC debate, which focuses on whether China’s digital yuan can imperil the dollar’s position as the world’s reserve currency. He suggested that if “dollar-backed stablecoins such as USDC are adopted, the threat to the dollar from cryptocurrencies and other central bank digital currencies is diminished.”
As for the dollar’s status, Barr suggested that dollar-backed stablecoins like Circle’s USD Coin “would benefit the U.S. dollar” — something Liang agreed with, if somewhat cautiously. Nor, she added, would private stablecoins interfere with a CBDC.
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