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Conor Svensson

Published On - February 2, 2023

The Future of Stablecoins

During the past year, there's been a large number of various blockchain initiatives being announced by financial institutions spanning cross-border payments, CBDCs — both retail and wholesale, asset tokenisation, post-trade settlement and DeFi.
Of these, it is the fate of stablecoins that is arguably clearest. 

Will they take crypto mainstream?

Australian Bank, NAB recently announced they were going to launch a Aussie dollar stablecoin  on the Ethereum and Algorand public blockchains. Last year J.P. Morgan tokenised deposits , and a number of U.S. banks formed the USDF Consortium to create a stablecoin. 
Stablecoins already account for a significant portion of the DeFi market . As I write this, the stablecoin market cap is  $137.12bn . The total value locked in DeFi protocols is a smaller  $46.88bn . This is against the wider $1.047tn cryptocurrency market cap. The fact that stablecoins account for over 13% of the total crypto market cap and are a crucial component of the DeFi ecosystem demonstrates their significant traction. 
Before we get into the popularity of stablecoins in web3, lets cover the basics on stablecoins: 

What are Stablecoins?

Stablecoins are a type of cryptocurrency designed to maintain a stable value, often pegged to a tangible asset like a fiat currency (e.g., US Dollar), commodity (e.g., gold), or a basket of assets. Unlike volatile cryptocurrencies such as Bitcoin or Ethereum, which can experience extreme price fluctuations, stablecoins aim to minimize this volatility and provide a more consistent unit of value for transactions and investments.

How do stablecoins work?

Stablecoins achieve stability through various mechanisms:
Fiat-collateralized: These stablecoins are backed by a reserve of traditional fiat currency, usually held in a bank account or custodial service. For every stablecoin in circulation, there is an equivalent amount of fiat currency held in reserve e.g. Tether (USDT) and USD Coin (USDC).
Crypto-collateralized: These stablecoins are backed by other cryptocurrencies. They rely on over-collateralization, meaning that more crypto assets are held as collateral than the stablecoins in circulation, reducing the risk of volatility affecting the value of stablecoins e.g. Dai (DAI) and USD (Synthetix USD).
Algorithmic: Algorithmic stablecoins use smart contracts and algorithms to automatically adjust the supply of stablecoins based on changes in demand, attempting to keep the price stable e.g. Terra (LUNA) and Ampleforth (AMPL).
Commodity-collateralized: These stablecoins are pegged to the value of commodities like gold or oil. The stablecoin issuer holds a reserve of the commodity to back the value of the stablecoins e.g. Paxos Gold (PAXG) and Tether Gold (XAUT).

Why are stablecoins important?

Reduced volatility: Stablecoins offer a middle ground between the volatility of traditional cryptocurrencies and the stability of fiat currencies, making them more suitable for everyday transactions and store of value. 
Cross-border transactions: Stablecoins enable instant and low-cost cross-border transactions without the need for intermediaries like banks. This has the potential to revolutionize remittances and international trade. 
Cryptocurrency trading: Traders can use stablecoins as a "safe haven" during times of high volatility. Instead of cashing out into fiat currencies, they can move their funds into stablecoins to preserve their value. 
DeFi ecosystem: Stablecoins play a pivotal role in decentralized finance (DeFi) applications, where users can lend, borrow, and earn interest on their assets without relying on traditional banks.
Decentralisation and crypto maximalists may not like how stablecoins pegged to the U.S. dollar are so popular in web3. But dollar-backed stablecoins provide a crucial rail. They link our existing financial system to a blockchain-enabled one.  Without stablecoins, DeFi and TradFi would be disjoint . The only way to embrace this emergent ecosystem would be via their native assets. Bitcoin, Ether and others via exchanges. 
This is how things were for early adopters of Bitcoin until Tether's USDT was launched in 2014. Circle's USDC followed USDT in 2018, and Binance and Paxos' BUSD in 2019 (we'll ignore those stablecoins that emerged and imploded such as Terra's UST). 
With the explosion in popularity of crypto, NFTs and DeFi during the past few years, confidence in the underlying technology has grown with it. Whilst investor confidence in cryptocurrencies isn't great at present, no one is calling out the technology as being unsound. It is only those  bad actors  who have abused the trust of their customers who are to blame not the technology. 
The upside of this increase in confidence in the technology underpinning blockchain networks is even more companies are now willing to embrace it — especially banks.  Fully collateralised  stablecoins, with  transparent reserves  (emphasis intentional), like the blockchain networks underpinning them have remained resilient during recent periods of stress in the cryptocurrency sector. 
Any organisation with significant deposits or cash reserves could in theory launch a stablecoin. This is a no-brainer opportunity for banks. They already have significant reach with their sheer number of customers and are already in the business of holding customer deposits. While there don’t appear to be  significant legal barriers , there are other barriers that exist for firms wishing to launch these products. It requires non-trivial expertise in smart contract development to build, deploy and manage these stablecoins. Firms too will need to work with or become a custodian of the keys used to manage the stablecoins on different blockchain networks. They will also need to ensure their customers are able to use the stablecoins. This requires competency with cryptocurrency wallets and addressing UX challenges still faced by users. 
However, once stablecoins are made available on blockchain networks, the issuers and customers benefit significantly. A customer can make a payment to anyone in the world in a matter of seconds with similar fees regardless of the amount being sent or where the recipient is. Unlike with a traditional bank payment, when this payment is made, the collateral held by the stablecoin issuer remains the same. It does not need to be debited from an account and subsequently netted off by the payee’s bank. For instance, when someone makes a payment from an account held by bank A to one that resides in bank B. 
This is a boon for stablecoin issuers as their funds can remain in circulation for longer than customer deposits, which translates into them being able to earn more on these deposits. The customers of banks are likely to be beneficiaries once the stablecoin landscape starts to heat up properly. At the current time, there simply isn't much competition. If you want the closest thing there is to a regulated stablecoin you go with USDC, if you're using Binance you probably use BUSD, and if you don't pay too much attention to the details perhaps you use USDT. 
When banks start entering the stablecoin landscape en-mass they're going to start competing for business. This would likely be in the form of offering stablecoin yields for holders. Imagine if these were paid directly to the crypto wallet holding a stablecoin? In fact, the EU's proposed Regulation on Markets in Crypto-assets (MiCA) is  proposing exactly this
There'll be some really interesting market infrastructure required too.
When used in payments, these bank-issued stablecoins will get swapped for other stablecoins. They may also be redeemed for their underlying currency. After all,  not all stablecoins will be universally accepted . Some retailers may accept only J.P. Morgan coins, whilst others may only support Bank of America coins. 
A stablecoin issuer will support redemptions for their users, but when one stablecoin needs to be exchanged for another, 
  • How will this be done? 
  • Will banks offer these services to their users? 
  • Will users make use of decentralised exchanges like Uniswap for this? 
Or perhaps we'll have native web3 payment protocols to which someone could send their JPM coins to convert and send them to another address as BAML coins. There is no doubt that as stablecoin adoption becomes more widespread, an ever greater amount of innovation will happen to provide a more seamless experience for users. 
We're still early in web3 as the mantra goes, however, it's really interesting to think about the trickle-down effect widespread adoption of certain innovations will have such as stablecoins. Much like the growth of fintech created a surge in app and usability focussed activities for banks, we are on the cusp of seeing something very similar happening for stablecoins
After all, when you're a bank, why wouldn't you be thinking about tokenising customer deposits? The landscape is wide open and it’s going to be fascinating to watch as the stablecoins landscape starts to gather momentum.
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