Banks Will Dominate Stablecoins & 2 More Money Future Predictions

As blockchain technology continues to develop over the next few years, cross-border payments will prove to be a game-changing use case. To grow, the industry needs user adoption, while users will adopt technology that meets a real need. In many ways, stablecoins are crypto’s most useful innovation to date.

The company that ultimately builds a Web3 application with a Web2 user experience will win. In payments, this means being able to harness the benefits of crypto (high-speed, low-cost transactions) while meeting all the stringent regulatory requirements that the US and Europe place on money transfer businesses. silver.

Chris Hayes is a senior government relations executive focused on financial regulation and Chris Ostrowski is the Managing Director and one of the founders of SODA. This article is part of CoinDesk “Political Week”.

Increasingly, in these jurisdictions, it seems that the players likely to capitalize the most in this area are regulated financial institutions, i.e. banks. Rather than “blowing up the traditional financial system”, crypto makes the traditional financial system much more efficient.

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

Based on the trends we’ve seen through engagement with central bankers and policymakers on the landscape of stablecoins and central bank digital currencies (CBDCs) in Europe and the US, we’re doing all three following predictions:

1. Fiat-backed stablecoins will continue to dominate developed markets, and thus the remittance market, while other stablecoin designs will be phased out.

Private stablecoins currently exist in two types – fiat-backed stablecoins, which are on-chain tokens backed by cash or off-chain cash equivalents in a bank account, and non-fiat-backed stablecoins, which are either pure algorithmic stablecoins with no backing reserves, or other designs backed by varying levels of on-chain guarantees. Both types of stablecoins remain outside of regulation, with the exception of nascent political regimes coming into effect in the European Union and the United Kingdom

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

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

The highly publicized failure of Terra not only caused an intense political backlash against stablecoins in general, but also served as an example of how these self-stabilizing mechanisms can be out of whack. (That was a lesson in functionality we didn’t learn from Titan/Iron, which failed before Terra.)

Second, algorithmic stablecoins that are not backed by fiat, but also not based on a “pure” algorithm, face significant policy and regulatory challenges. These designs, as currently structured, do not meet the current liquidity expectations of EU and US prudential regulators.

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

As a result, emerging stablecoin regulatory frameworks in the United States and Europe have already made or likely will in the future make it very difficult for non-fiat stablecoins to exist or be used for payments. This will make them much less useful for payment applications, including remittances, which typically flow from developed to developing countries.

As we have seen, the new Crypto Asset Markets (MiCA) regulation in the EU makes it impossible for a non-fiat-backed stablecoin to be marketed as being pegged to the euro, without it holding significant verifiable reserves in off-chain bank accounts. . Although there are ways to circumvent these regulations, it is more difficult to compete with players who can operate within the regulatory framework and offer the expected security to users.

See also: What is the interest of stablecoins? Understand why they exist | Notice

Likewise, a stablecoin bill in the United States, which was discussed last year by then-Financial Services Committee Chair Maxine Waters (D – Calif.) and then Republican Patrick McHenry (R–NC), would impose a moratorium on all new entrants into the US until a US Treasury Department report is released, preventing any new stablecoin entrants. Moreover, it is likely that the Treasury would recommend restricting the use of stablecoins after the completion of its assessment and report.

These regulatory frameworks clearly indicate the direction developed markets are heading and how prudential regulators view stablecoins.

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

China’s determined pursuit of the central bank’s digital currency, colloquially known as the digital yuan, is a source of concern for central bankers and policymakers in Europe and the United States. While it is difficult to gauge the effectiveness or use of Chinese CBDC, its very existence presents an unknown challenge. to the established monetary order.

Other countries, including the Bahamas, Nigeria, and Jamaica, have followed suit by launching a retail CBDC and have found adoption to be the biggest barrier to usage. In other words, the promises of financial inclusion and digitalization of the economy are yet to be fulfilled, as too few 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 currency. Without clear benefits, citizens will continue to use cash, commercial bank money or e-money in more developed and less developed economies.

Public policy discussions regarding CBDCs will continue to be dominated by politically charged issues such as privacy, anonymity, cybersecurity, and government control. Less publicly, many central bankers will continue to explore how they can protect their currencies from threats from electronic yuan, cryptocurrencies, and Big Tech players entering the payments space with their own tokens.

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

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

A globalized wholesale CBDC regime covering Europe, the United States and Asia could revolutionize the banking sector and give an innovative role to private stablecoins backed by traditional banking institutions as long as there is international coordination in this regard. of regulation.

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

With increasing regulatory pressure on trust-backed stablecoins, the potential development of a wholesale CBDC in the US 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 prepared to enter the stablecoin space.

Traditional financial institutions have a head start given their existing legal and compliance functions, and may even benefit from the support of banking regulators in pursuing stable operations. Additionally, along with their retail client accounts, banks have a built-in user category for stablecoins.

Due to the regulatory moat and existing infrastructure, banks’ stablecoin efforts would have lower funding and customer acquisition costs than new players such as USDC issuer Circle. And they have a vested interest in generating more revenue for themselves with payments made on the blockchain, rather than through established payment networks like Visa and Mastercard.

As the EU finalizes the MiCA regulation and works on the digital euro, we will start to see European banks enter the front lines of the stablecoin space in the EU. There has already been significant involvement in blockchain from players such as BNP Paribas, Deutsche Bank and Société Générale.

In the United States, a policy priority of the Biden administration and Rep. McHenry, now chairman of the House Financial Services Committee, is finding a way forward for stablecoin regulation, given its direct impact on the traditional financial system.

See also: Stablecoins’ Niche Application Isn’t a Bad Thing | Notice

The battle continues over 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 couple of years. years. Once that’s done, expect traditional banks to go wild in the stablecoin market and stablecoin payouts to be an option in your bank account in this decade.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.