As global regulators wrestle with the Catch-22 balance of safety and innovation of cryptocurrency, stablecoins remain crypto’s way toward escape velocity, particularly in the developing world where safe banking services are scarce and political unrest is common. In fact, stablecoin volume hit a record high of US$7.4 trillion in 2022, which is more than the transaction volume of many major credit card companies. Even though stablecoin volumes have been down this year, as inflation continues to rise, there is a greater global need for stable currency than ever before.
Not all stablecoins are alike
Stablecoins play a pivotal role as a safe haven medium of exchange in high-inflation countries as well as within the crypto economy. It’s important to note that not all stablecoins are alike, and it’s paramount for regulators and users to understand the differences, even more so in the United States with the Biden administration’s Operation Chokepoint 2.0 that seems aimed at gathering the powers of all government agencies against crypto’s growth.
A 2023 International Monetary Fund Working Paper reaffirmed that stablecoins in Latin America “proved successful in preserving savings and protecting livelihoods, granting the benefits of crypto assets but without their extreme volatility.” These qualities make stablecoins desirable. However, there are a few other important features that stablecoins can offer to bring us into the 21st century of useful, transparent and fair money.
- Programmability — Stablecoins should be able to do certain things automatically, without corruptible, rent-seeking middlemen. The ability for entrepreneurs, businesses and governments to create stablecoins to meet a range of possibilities from self-healing stability, personal privacy and true ownership, autonomously, is a capability that is made possible through decentralized blockchains.
- On-chain, auditable proof of reserves — Stablecoins should have on-chain proof of reserves that provides transparency of the types and amounts of collateral so that users can choose assets that fit their risk profile.
- Decentralized community governance — Confidential pacts that favor a select few don’t fit in the 21st century. Public accountability is a force multiplier to prevent fraud and negligence, and it helps citizens choose systems that represent their values.
- Diversified basket of assets — A stablecoin that is backed 1:1 by a diversified basket of assets offers a more decentralized and safer solution by spreading out risk. The currency can remain stable and secure and self-healing, even when institutions and governments fail.
- Revenue sharing — Traditional banks and even first-mover stablecoins have historically kept revenue for themselves. Newer, decentralized stablecoins offer shared revenue on-chain, with users and other stakeholders creating a new financial system based on a regenerative paradigm of sharing.
Risks and barriers to adoption
As important as stablecoins are to empowering people with a stable store of value amid the volatility of crypto markets and inflation in fiat markets, there are some risks to be aware of.
- Depeg risk
Circle’s USDC experienced a drop to US$0.88 from its US$1 peg in the fallout from the March 2023 run on Silicon Valley Bank, where Circle kept US$3.3 billion of its US$40 billion reserves. The solution here is a “self-healing” stablecoin design wherein 1:1 asset-backing is diversified and overcollateralized and can autonomously recapitalize during a black swan event.
Another cause of stablecoin de-pegging can be a lack of transparency in the issuer having sufficient reserves to back the stablecoin at a 1:1 exchange ratio. This opacity can further propagate misinformation and uncertainty. Tether (USDT) dropped to US$.98 post-FTX’s implosion due to doubts from holders on whether there actually were reserves equal to or greater than the stablecoins in circulation. Implementing on-chain proof of reserves that allows anyone to conduct audits and verify that the assets supporting the stablecoin are equal to or greater than the total supply can effectively mitigate this concern.
- Smart-contract risks
Decentralized stablecoins represent a transformative paradigm shift, replacing middlemen with smart contract automation. While this increases system efficiency, transparency and integrity over the long run, it may introduce a complex learning curve and system vulnerabilities. To minimize the risks associated with smart contracts, the most secure approach involves utilizing stablecoins that have undergone a rigorous combination of comprehensive system testing, independently-conducted audits, and white-hat hacker bug bounties.
- Regulatory risks
Elected representatives and regulators are emphasizing the importance of safeguarding consumers and investors, promoting transparency, and ensuring accountability in the crypto industry. However, the process of developing and implementing regulations is moving slowly. Rather than being viewed as a risk, these initiatives should be seen as an opportunity. When effectively implemented, they have the potential to unlock wider adoption and use cases including accessing the multi-trillion dollar traditional finance capital markets. In the European Union, legislation concerning stablecoin issuers is slated to be enacted in 2024, while in the United States, such regulations are still in the early stages of development. Governments in the United Kingdom, Singapore and Abu Dhabi are also racing to provide regulatory clarity, aiming to attract cryptocurrency businesses and foster entrepreneurial innovation.
The future of stablecoins
The progression toward decentralized, asset-backed stable money has the potential to enhance payment and financial services, increase access to billions of underserved people, and transform our financial system into something more fair and transparent. Especially in light of global inflation rates on the rise, the need for stable currency has never been more clear. Expect to see growing interest in stablecoins in the parts of the underserved world that need it most.
The next decade is an era of unbundling and reinvention, unlikely to land on one stablecoin to rule them all. The incentive to use one-size-fits-all money is decreasing, as creating and switching currencies becomes easy and inexpensive and programmability introduces new benefits.
Even though stablecoins’ underlying technology, blockchain, is in its infancy, user adoption is growing exponentially. As of the end of 2022, there were already 425 million crypto wallets that represent 5% global penetration. Following recent years’ growth rates, this could become one billion people by 2025. Stablecoins promise a more accessible system of basic financial services for billions of people and inspire new ways for networks to form, build, and create community livelihood.
Stablecoins play a crucial role in fostering crypto adoption and serve as a gateway for the developing world to access financial opportunities that have long been exclusive to the West. As a catalyst for the emerging financial system, stablecoins resemble a small yet impactful ripple in a larger transformation. Moving from a fractional to a whole 1:1 asset-backed system is how we make banking safe again, for everyone.