Singapore-based Global Finance and Fintech Expert Angela Fan discusses the current global context on stablecoin and weighs the probability of its future viability.
By Angela Fan
Stablecoins, Tether, has captured a significant market capital of USD 4 billion and Libra is another global project that is currently under scrutiny. In addition, we are witnessing central bank issued digital currency initiatives around the globe, including China, and the UK.
For those new to this market, stablecoin is designed to improve the efficiency of global payments and to eliminate the high volatility feature of other type of crypto currencies such as Bitcoin to support the exchange process as well as to provide liquidity of the cryptocurrency market.
According to a recent McKinsey Global Payments Report, global payment revenue grew by 11% from 2016 to 2017, partly attributed to the declining cost of payments. An ideal global payment mechanism is often sought to provide higher financial inclusion of global payment market.
The touted benefits of an ideal global payment mechanism are arguably increased security, privacy, lower transaction costs, a more broadly-adopted ecosystem, greater price stability and ease of use.
Currently, there are several types of stablecoin on the market.
We have private sector cryptocurrency stablecoin; collateralized, non-collateralized, and Hybrid etc. In the mainstream, collateralised stablecoin is backed by one or a portfolio of assets which define the value mechanism of the stablecoin. Tether is the most famous example, which is backed by USD, a fiat currency. Other non-fiat assets such as gold, precious metal, and crypto assets also work as an underlying asset of the stablecoin to achieve price stability.
At the moment, the most widely used stablecoin is Tether (USDT). It has captured about USD 4 billion market capital as of January 2020. This coin is also traded at several crypto exchanges, together with Bitcoin, Ethereum, and Litcoin.
Besides USDT, there are other stablecoin projects pegged to different fiat currencies including EURO, SGD, etc. Such traction across the globe caught the imagination of tech giant Facebook, which recently published its Libra whitepaper, a proposed, global stablecoin designed to be backed by a basket of fiat currencies such as USD, EURO, etc.
In the case of asset collateralised stablecoin, stablecoin becomes a mechanism of digitising stable assets to provide liquidity to the market. Any asset which has value can be easily digitised on blockchain by being attached to a stablecoin issuance. In a way, stablecoin is not only a payment mechanism but also becomes an asset tokenizing tool.
There is also central bank issued digital currency, which is the digital form of fiat money (a currency established as money by government regulation or law).
The Bank of England was one of the first to initiate a global discussion on the prospects for the introduction of a CBDC. After Facebook issued the whitepaper of Libra, to counter the rise of private stablecoin like Libra, this precipitated central banks around the world to enter the fintech race, with plans to issue digital currencies of their own.
The Central Bank of China is one global frontrunner set to launch its own digital currency. Other regions including the United States and Europe are currently in discussions and considering concepts. As early as 2017, the Central Bank of Uruguay announced plans to begin testing its digital Uruguayan pesos.
The obvious benefits of a central bank issued digital currency includes faster, cheaper, and more efficient payments, both domestically and cross-borders. In addition, removing the cost of handling paper money and expanding financial inclusion are also key drivers.
While the prospects of stablecoins appear promising, challenges remain:
Auditory requirements – reserve for future investor redeem request needs to be validated by reliable independent auditors, which is not currently available in the market.
Centralization – Regardless of private or central bank issued coins, a centralised party, instead of a distributed network, is required to issue and govern the coin issuance.
Education resource for adoption – The technology mechanism will take education to reach mass consumer adoption; and
Regulations compliance for commercialization – Shaping stablecoin as a global payment scheme, regulators have concern in risks of bankruptcy, financial crisis and AML compliance to all the relevant regulations will take time to realise.
Global, regulatory perspectives
While no consensus has been reached among regulators, a few central banks and regulators stated their view about Libra, the global stablecoin project by Facebook, and the overall stablecoin initiatives.
When it comes to the single fiat currency backed stablecoin, there is less concern or rejection raised from regulators. As an example, Thomas Jordan, chairman of Swiss Central Bank expressed a professional view of no issue with stablecoins backed by Swiss francs, operating within Switzerland –
“As long as prices, wages and loans are set in Swiss francs, the SNB can influence incentives for savers and borrowers via its monetary policy and thus ensure price stability over the medium term,” says Jordan.
As to Libra, a global stablecoin backed by multiple fiat currencies, regulators stated some concerns:
The Swiss Central Bank Chairman Thomas Jordan argued recently that if stablecoins pegged to foreign currencies were to establish themselves in Switzerland, the effectiveness of its monetary policy may be impaired.
On the US Congress front, Chair of the US Congress House Financial Services Committee Maxine Waters was more candid about misgivings on Facebook’s Libra project.
“It appears that these products may lend themselves to an entirely new global financial system that is based out of Switzerland and intended to rival U.S. monetary policy and the dollar. This raises serious privacy, trading, national security, and monetary policy concerns for not only Facebook’s over 2 billion users, but also for investors, consumers, and the broader global economy. Failure to cease implementation before we can [examine the implications in a committee hearing], risks a new Swiss-based financial system that is too big to fail,” says Waters.
The expression ‘too big to fail’ is usually applied to large banks that would disrupt national economies if they collapse.
The Bank of England also forewarned Facebook to expect a high degree of scrutiny in its quarterly laundry list of worries. It added that the various links in the chain underscored “the need to ensure end-to-end resilience”.
“The resilience of the proposed Libra system would rely on the stability of not just the core elements of the Libra Association and Libra Reserve but also the associated critical activities conducted by other firms in the Libra ecosystem such as validators, exchanges or wallet providers,” according to the The UK central bank report.
French Economy Minister Bruno Le Maire did not hold his peace on Libra either, bluntly stating that Libra “is not welcome on European soil”. Speaking in Washington on the sidelines of the World Bank and International Monetary Fund autumn meeting, Le Mairie affirmed that France “will take steps with the Italians and Germans, because our sovereignty is at stake”.
On the other hand, the Bank of Japan (BOJ), warned that uncertainties over the effect of CBDCs on commercial banking must be addressed. The BOJ has also scotched the idea that CBDCs could boost the effectiveness of negative interest rate policies.
With the significant investment in blockchain and stablecoin initiatives, the debate among private sectors and regulators demonstrate stablecoin has caught the imagination of key industry players and influencers.
While regulators are being forthright with concerns, fine-tuning alternative technology solutions appears to continue being explored and tested; time will tell whether we will see future alternate financial systems that offer greater efficiency and security going forward.
(Featured image of US Congresswoman Maxine Waters by Photographer Andrew Harrer.)