Most of the excitement surrounding cryptocurrency has focused on Bitcoin and similar altcoins. This is understandable, as this asset class accounts for over 95% of the market value assigned to digital currencies and has been responsible for eye-popping returns in recent years.
Lurking just outside the spotlight are Bitcoin’s unassuming cousins, stablecoins – a form of cryptocurrency that is usually pegged to fiat money or physical assets to maintain a set value. Stablecoins may hold the key to delivering crypto’s promise to mainstream financial services because they retain most of cryptocurrency’s positive attributes, such as cheaper and faster transaction settlement, but without the price fluctuations.
While the latter may eliminate the feature that sets day traders’ hearts racing, it also makes cryptocurrency’s use as an exchange medium more realistic. Ironically, today’s most common stablecoin use case is on crypto exchanges, enabling traders to reduce their risk by shifting into less-volatile cryptocurrencies.
Before dismissing this as a fringe situation, consider that stablecoins are already being used to settle nearly $6 trillion in annual transaction volume. That’s roughly half of Visa’s throughput. Assuming that statistic piques your interest, let’s consider how and where these digital assets can be applied.
Staying Tethered to the Dollar
There are four subgroups of stablecoins, categorized by how each pegs its value. The most popular are backed by fiat currency – typically the US dollar – on a one-for-one basis. The best known of these are Tether (the #4 cryptocurrency as measured by market capitalization), USD Coin (#7), and Binance (#16). You’ll find each trading at precisely $1.00 on leading crypto exchanges.
The fiat collateral underpinning these coins is placed in reserve with a central issuer or financial institution. Crypto experts sometimes refer to these coins as “off-chain assets” as the underlying collateral doesn’t itself reside on the blockchain. Commodity-backed stablecoins apply a similar model, using physical assets like gold, oil, and real estate as collateral. However, since these underlying assets fluctuate in price, such coins’ values are less stable.
While addressing some primary concerns limiting the usefulness of crypto like Bitcoin, these subgroups have some risks and drawbacks. Its underlying collateral is encumbered, restricting its productive use. Collateralization arrangements can be difficult to audit. Additionally, a central issuer’s failure or reputational crisis could imperil the stablecoin issued.
Crypto-collateralized stablecoins and non-collateralized stablecoins, which use algorithms to manage the asset’s market value, also exist. Except for DAI, a crypto-collateralized instrument that has retained a value close to $1.00 and has become the 26th largest coin by market cap, these more complex instruments remain less common.
Settling for the Mass Market
JPMorgan Chase has been very active in this space, developing a US dollar-pegged JPM Coin to transfer funds between the bank and commercial clients. JPM’s embrace of the technology is particularly notable given CEO Jamie Dimon’s well-publicized disdain for Bitcoin. This reinforces stablecoin’s unique value proposition. In a similar vein, Visa has enabled USDC as a settlement option across 70 million of its network merchants.
The interest of major financial services players is natural given stablecoin’s compelling use case for cannibalizing existing card payment rails and vehicles like wires, checks, ACH, and SWIFT’s international settlement network. Central Bank Digital Currencies (CBDCs) – a variant of stablecoin – could save businesses $100 billion annually in cross-border settlement costs, according to JPMorgan research.
Regulators have also taken note, with the President’s Working Group on Financial Markets telegraphing interest in greater stablecoin oversight. Whether regulatory clarity emerges from Congress or federal agencies, such actions will lend legitimacy to and further the adoption of stablecoins. Such actions would also impose new compliance burdens. Some crypto issuers have already pursued banking licenses or partnered with banks anticipating such moves.
The Bottom Line
Stablecoins are punching above their weight, generating more transaction volume than their $115 billion market cap would indicate. Major banks are already using the technology, which offers significant potential for faster payment settlement at a lower cost. Prospective legislation will likely move stablecoin further into the mainstream. Our most recent webinar dives into more detail on stablecoins – watch it here.
SRM is closely monitoring ongoing developments in the crypto space, and we believe 2022 will be a critical year for strategic decision-making. Now is the time for banks and credit unions to prepare an action plan.
Author: Mike Lawson
Married to a most gorgeous and wonderful wife, raising 5 kiddos (including twins!), enjoy helping others tell their stories, and love surfing SoCal waves. Keep it simple.