Banks Will Dominate Stablecoins, and 2 Other Predictions About the Future of Money

Crypto, rather than "blowing up" traditional finance, is making the existing system more efficient.

AccessTimeIconJan 27, 2023 at 4:34 p.m. UTC
Updated Sep 28, 2023 at 2:27 p.m. UTC
AccessTimeIconJan 27, 2023 at 4:34 p.m. UTCUpdated Sep 28, 2023 at 2:27 p.m. UTC
AccessTimeIconJan 27, 2023 at 4:34 p.m. UTCUpdated Sep 28, 2023 at 2:27 p.m. UTC

As blockchain technology continues to develop over the coming years, cross-border payments will prove to be a game-changing use case. In order to grow, the industry needs user adoption while users will embrace a technology that fills an actual need. In many respects, stablecoins are the most useful innovation to come from crypto to date.

The company that finally builds a Web3 based application with a Web2 user experience will win. In the realm of payments that means being able to harness the benefits of crypto (high-speed, low-cost transactions) while meeting all the stringent regulatory demands the United States and Europe has over money-transmitting businesses.

Chris Hayes is a senior government relations executive focused on financial regulation and Chris Ostrowski is chief executive officer and a founder of SODA. This article is part of CoinDesk’s “Policy Week.”

Increasingly, in these jurisdictions it looks like the players set to capitalize most in this arena are regulated financial institutions – i.e., banks. Rather than “blowing up the traditional financial system” crypto is making the traditional financial system significantly more efficient.

This has happened before: At the dawn of the first wave of digital disruption fintechs were predicted to “eat up” and replace existing institutions. Instead, the banks integrated the software that supposedly threatened them either by acquisition or osmosis.

Based on the trends we’ve seen through engagement with central bankers and policymakers on the landscape for stablecoins and central bank digital currencies (CBDC) in Europe and in the U.S. we make the following three predictions:

1. Fiat-backed stablecoins will continue to dominate developed markets, and therefore the remittance market, while other stablecoin designs drop by the wayside.

Private stablecoins exist currently in two types – fiat-backed stablecoins, which are on-chain tokens backed by off-chain cash or cash equivalents in a bank account, and nonfiat-backed stablecoins, which are either pure algorithmic stablecoins with no backing reserve or other designs backed by various levels of on-chain collateral. Both stablecoin types remain outside of regulation, except nascent policy regimes coming into force in the European Union and U.K.

Algorithmic stablecoins use self-regulating mechanisms to keep their private stablecoins pegged to another currency, a system that has had a rocky history. Typically, on-chain collateral consists of cryptocurrencies like BTC or ETH, fiat-backed stablecoins like USDC or USDT and a few nascent traditional financial assets brought on-chain (for example, there is a tokenized money market fund on Stellar, a tokenized green bond on Ethereum and some other efforts to tokenize traditional financial assets).

The collapse of Terra's terraUSD, a “pure” algorithmic stablecoin, has had a significant impact on the global stablecoin market. First, and perhaps most importantly, it has likely doomed any other type of algorithmic stablecoin from establishing a similar amount of trust.

Terra’s highly publicized failure has not only stirred intense political backlash against stablecoins generally but served as an example of how these self-stabilizing mechanisms can be knocked off-kilter. (This was a lesson about functionality we didn't learn from Titan/Iron, which failed before Terra.)

Second, algorithmic stablecoins that are nonfiat-backed, but also not “pure” algorithm based, face significant political and regulatory challenges. These designs, as currently structured, fall short of meeting the current liquidity expectations of prudential regulators in the EU and United States.

Third, fiat-backed stablecoins feel familiar to prudential regulators. They seem relatively simple to understand and, unlike collateralized designs with on-chain assets, present a more conventional risk profile. While fiat-backed stablecoins may have their own risks around lack of transparency behind their collateral holdings, prudential regulators can address those through regulation and enforcement.

As a result, the emerging stablecoin regulatory frameworks in the U.S. and Europe have already or will likely in the future make it very difficult for nonfiat stablecoins to exist or be utilized for payments. This will render them much less useful for payment applications, including remittances, which generally flow from developed countries to developing countries.

As we’ve seen, the new Markets in Crypto Assets (MiCA) regulation in the EU makes it impossible for a nonfiat-backed stablecoin to be marketed as being pegged to the euro, without it holding auditable significant reserves in off-chain bank accounts. While there are ways to navigate around these regulations, it makes it harder to compete with those players that can operate within the regulatory framework and provide the expected safety for users.

Similarly, a proposed stablecoin bill in the U.S., which was discussed last year by then-House Financial Services Committee Chair Maxine Waters (D–Calif.) and then ranking Republican Patrick McHenry (R–N.C.), would impose a moratorium on all new nonfiat-backed stablecoin releases in the United States until the release of a report from the U.S. Treasury Department, hobbling any new stablecoin entrants. Moreover, it’s likely the Treasury would recommend restricting stablecoin use after its evaluation and report concludes.

These regulatory frameworks make it clear the direction developed markets are headed and how prudential regulators view stablecoins.

2. Retail CBDCs are viewed cautiously in the US and Europe, while wholesale CBDCs continue to grow.

China’s determined pursuit of the central bank digital currency colloquially known as the digital yuan is a cause for concern for central bankers and policymakers in Europe and the U.S. While it’s difficult to assess the effectiveness or usage of China’s CBDC, its very existence represents an unknown challenge to the established monetary order.

Other countries, including the Bahamas, Nigeria and Jamaica, have followed suit in launching a retail CBDC and have found adoption to be the biggest barrier to usage. In other words, promises of financial inclusion and digitalizing the economy are yet to be made good, as not enough citizens have used the CBDC.

Future retail CBDC pilots and launches will focus more on use cases that are unique to this particular form of tokenized public digital money. Without clear benefits, citizens will continue to use cash, commercial bank money or e-money in both more developed and less developed economies.

Public policy discussions around CBDCs will continue to be dominated by politically charged issues such as privacy, anonymity, cyber-security and government control. Less publicly, many central bankers will continue to explore how they can future proof their currencies from the threats of the e-yuan, cryptocurrencies and Big Tech actors moving into the payments space with their own tokens.

A combination of use-case testing, cross-border settlement and smart contract-enabled payment innovations will become public in 2023 as this work continues. The political environment makes it very unlikely that traditional banks would be willing to become virtual wallet providers for the central bank, which presents a political obstacle to adoption of retail CBDCs in the U.S. and Europe.

Wholesale CBDCs hold significant promise and offer blockchain enabled atomic settlement between central banks and financial institutions in any given country. There is much hope that 2023 will finally see a wholesale CBDC solution for cross border payments, perhaps spearheaded by the Bank for International Settlements (BIS), though there have been false dawns before.

A globalized wholesale CBDC regime spanning Europe, the U.S. and Asia could revolutionize the banking sector and provide an innovative role for private stablecoins backed by traditional banking institutions as long as there is international coordination on regulation.

3. Traditional banks will dominate the stablecoin market once there is regulatory certainty in developed markets.

With increasing regulatory pressure towards fiat-backed stablecoins, the potential development of a wholesale CBDC in the U.S. and Europe, as well as a consumer flight to safety in the crypto market, the market is ripe for traditional banks to dominate the stablecoin market. Once regulatory certainty is achieved, traditional banking institutions will be well set up to enter the stablecoin space.

Traditional financial institutions have a leg up considering their existing compliance and legal functions, and may even have support from the banking regulators in pursuing stablecoin businesses. Plus, with their retail customer accounts, banks have a built in category of users for stablecoins.

Because of the regulatory moat and existing infrastructure, banks’ stablecoin efforts would have lower funding and customer acquisition costs compared to newer players such as USDC-issuer Circle. And they have every incentive to drive more revenue to themselves with payments conducted on blockchain, rather than through established payment networks like Visa and Mastercard.

While the EU finalizes the MiCA regulation and works on the digital euro, we’ll start to see European banks enter the forefront in entering the stablecoin space in the EU. There’s already been significant involvement in blockchain from players including BNP Paribas, Deutsche Bank and Societe Generale.

In the U.S., a policy priority for the Biden Administration and Rep. McHenry, now the chair of the House Financial Services Committee, is to find a path forward on stablecoin regulation, given its direct impact on the traditional financial system.

The battle continues on whether only traditional banking institutions will be able to issue stablecoins, and that, along with the tight political margins in the House of Representatives, makes it unclear if legislation can move forward in the next two years. Once it does, expect the traditional banks to be unleashed in the stablecoin market, and stablecoin payments to be an option from your bank account sometime this decade.

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Chris Hayes is a senior government relations executive focused on financial regulation. He previously led global government relations for a layer 1 blockchain.

Chris Ostrowski

Chris Ostrowski is chief executive officer and a founder of SODA.