As financial leaders around the world look to fortify and evolve business models with an eye toward ongoing innovation, many are turning their attention toward digital assets and crypto markets.
In a relatively new marketplace with little historical data, one might not expect to see digital assets and crypto markets as top of mind for most executives. However, one type of crypto in particular, stablecoins, has garnered significant attention as enterprises seek out ways to add new revenue streams, as well as diversify and better customize their offerings. Having exploded in size from low single billions to over $150B in approximately three years, stablecoins are rapidly proving to be the best bridge between traditional finance and crypto.
A basic understanding of the use cases for stablecoins can help to identify what future customers will likely be looking for in their banking, financial and payment experiences.
Stablecoins are cryptocurrencies where the value is pegged, or tied, to that of another currency or commodity and pursue price stability by maintaining reserve assets as collateral.1
1Hayes, A.“What is a stablecoin?” https://www.investopedia.com/terms/s/stablecoin.asp
Increasing number of uses for stablecoins
Stablecoins live on a blockchain, which makes them capable of settling transactions almost instantly at almost zero cost, leading to significant adoption. However, simple payments alone are not the only use case, and the composability of stablecoins and smart contracts, in general, are driving growth:
- With personal remittances estimated at approximately 8% of global GDP and growing, the ability to transact in a global, peer-to-peer manner is helping spur stablecoin growth.
- As uncertainty persists around the globe, some see regulated USD stablecoins as safe havens in regions associated with frequent financial turmoil.
- Owning a stablecoin also means one can participate in crypto markets without exposure to the higher risks associated with non-fiat pegged cryptocurrencies.
- Trading and lending are also common uses of stablecoins because they can help avoid fees as one might look to temporarily lock in value instead of continually cashing in and out.
- Accepting and making payments in stablecoins fits perfectly in a mobile phone-operated, travel-friendly world.
Using stablecoins for payments is getting easier
Payments might be the most commonly impacted financial experience for many of us, as we see the option of using stablecoins for payments become more ubiquitous when shopping – both in person and online.
Many in the financial services industry have long believed the need for innovation in payment processing is clear, as the fees and T+days settlement times make it inefficient for those transacting in smaller denominations, and the process is not aligned with a digital, 24/7 world.
For merchants looking to engage with their customers and offer better products, crypto can reduce working capital, settlement times, and thus costs, as well as open up other opportunities, such as making crypto part of a unique customer loyalty program reward.
Stablecoins also hold the potential to help other, nascent innovations in payment systems to flourish, such as programmable payments, which are secure, automated payments triggered by blockchain-based systems or smart contracts.
A smart contract is a self-executing contract with the terms of the agreement between buyer and seller being directly written into lines of code.2
2Frankenfield, Jake, Investopedia, https://www.investopedia.com/terms/s/smart-contracts.asp
As enterprises and institutions improve payment systems, they may be connecting cryptocurrencies with future end users, as innovation in this area is generally beneficial to all parties.
Growing interest in secure stablecoins
Defining what stablecoins are can also help one to better understand their utilitarian value, but until now, that’s been a challenge as some stablecoins – notably those not tied to a fiat currency – have been calling themselves stablecoins while failing (sometimes dramatically) to live up to that moniker.
However, with serious attention being given to banning non-fiat pegged stablecoins in the US, favorable sentiment seems to be building around fiat-backed stablecoins pegged to the US dollar, such as BUSD and USDP, both of which represent one dollar on the blockchain.
Among those seeking out secure, fiat-pegged stablecoins are populations looking to use them as a store of value or a medium of exchange on blockchain networks. With a low barrier to entry for owning stablecoins and their relative ease and convenience of use, many see them as potentially driving financial inclusivity – providing every individual the power to move assets instantly and securely, 24/7, cheaply, without the need of a bank, around the clock, regardless of location.
All of this hinges on the fact that stablecoins are secure, because, for many, they represent a more trusted way of transacting and holding assets, perhaps because they live in areas where trust in traditional banking has been diminished or where the financial infrastructure is simply underdeveloped.
Though the industry definition of a stablecoin may vary, at Paxos, we believe all properly constructed stablecoins should meet the following criteria to truly be called a “stablecoin,” as outlined in one of my earlier posts:
- Clear matching of tokens to reserves, where all stablecoins are at least 1:1 backed by cash and cash equivalent reserves at all times.
- Transparency of reserves, so that holders of a stablecoin have complete and total knowledge of the specific assets backing the coin.
- Availability, such that the creation and destruction of a stablecoin, as well as the commensurate sending of dollars via traditional rails, is easily achieved.
- Controls and oversight, with a primary prudential regulator ensuring there are attestations, audits, and examinations of controls such that a stablecoin issuer’s operations are at or above the standard of traditional financial institutions handling fiat.
- Reserve management practices, including binding investment guidelines, that limit reserves to conservative assets that would perform well in periods of genuine financial stress, such as 2008.
- Fiduciary duty to ensure that the issuer places the customer’s interest ahead of their own.
- Segregation of funds to insure that they are bankruptcy remote and never leave legal possession of the customer.
Regulated stablecoins pegged to the value of an underlying asset with reserves in custody are considered less volatile than unregulated stablecoins. Paxos’ stablecoins, BUSD and USDP, are tied to the US dollar, and as regulated stablecoins, their reserves are held bankruptcy remote, and are subject to strict regulatory oversight by the New York State Department of Financial Services.
This means that for anyone owning BUSD or USDP, their digital dollar is always redeemable for a dollar.
Long-term impacts of stablecoins
For business leaders, the advantages of stablecoins don’t stop at today’s marketplace, for it’s the future 24/7, global marketplace that may see stablecoins as critical components for innovations not yet discovered. As merchants want to continually increase engagement with their customers in the digital age, so do financial institutions and other new players in the financial services industry and thus more innovations are likely.
Though the stability of a regulated stablecoin may not draw as much interest from investors (as they aren’t designed to increase in value), they may make a model cryptocurrency for everyday use in routine activities such as paying for a Starbucks’ coffee or sending money to a friend halfway around the world. Likewise, they will prove to be a foundational layer for institutions moving traditional financial activity onto the blockchain.
Most enterprises understand that creating more on-ramps to their network, with more ways to engage with the network once on it, inspires higher levels of engagement with more valuable customer touchpoints for an ever-growing population looking to learn about crypto.
And while all of this activity is reason enough for enterprises to see the potential value in long-term stablecoin usage, there’s yet another opportunity for growth that may become more significant in the near future: Web3 participation.
For those looking to take the lead in a Web3-based marketplace of instant, global connectivity, stablecoin offerings can be seen as a viable and low-cost entry point that captures the attention of, and meets the needs of your customers as they begin to navigate new networks. More so, having a well-regulated stablecoin that exists on public blockchains means that the offering of any company utilizing them becomes instantly interoperable with any other platform that accepts stablecoins, greatly increasing the network effect for all.
This helps to put the long-term power of connectivity into the hands of the people one does business with, prompting more consumer activity and solidifying existing relationships.
Ultimately, this may be the road stablecoins pave, one that is stable enough to be trusted, nimble enough to move assets securely and instantly, and accessible enough to ensure sound banking isn’t out of anyone’s reach.
Want to know more about regulated stablecoins? Learn more here.