Thanks in no small part to Facebook’s controversial Libra project, stablecoins have attained a great deal of interest in recent months and many questions have been thrown up about their place in the global financial system. How many stablecoins might exist with in a few years? What are the benefits and risks to banks and central banks? What technical and regulatory standards would need to be applied to facilitate worldwide adoption?

Stablecoins have been part of the cryptocurrency conversation for several years, often looked on as the more respectable face of crypto. Without the price volatility or tarring with the brush of criminal activity, stablecoins have been regarded as a more feasible means of frictionless digital payment than Bitcoin. However, they would still have their own share of barriers with which to contend.

Considering Tether, which is linked to the US Dollar, any coins that users hold would need to be backed by some sort of basket or reserve of fiat currency, which needs to be managed by someone.

“That’s when you run into the risk of fraud or the people in charge of this reserve using it in a way that diminishes its value,” Johan Javeus, chief strategist at SEB, says to Finextra Research.

“Then the whole system could collapse if someone steals the reserve or does something that means the coins are not worth as much.”

In some ways the risks associated with cryptocurrencies could be just as dangerous for stablecoins, even if price volatility is less of a concern. Bitcoin, for example, has often been used for illegal and illicit purposes such as the sale of drugs or weapons. A stablecoin like Tether could in fact be more attractive to criminals as a means of exchange.

“If I was a drug dealer, I would probably prefer my clients to pay me in Tether than Bitcoin,” Javeus says, “because I’m in the business of selling drugs, not the business of speculating about the future value of Bitcoin.”

Any digital currency, whether it be Tether, Bitcoin, Libra or a CBDC (central bank digital currency), is designed to remove some of the frictions that pertain to transferring money from one place to the other. Where frictions are removed, risks will appear, hence the ongoing concerns from the world’s financial leaders towards all forms of crypto, including stablecoins.

Facebook moves the dial

Facebook’s announcement of its intention to launch its own cryptocurrency in June 2019 signaled a surge in interest around stablecoins and the possibilities for CBDCs.

The Libra project however came in for almost universal criticism from governments and regulators, who were clearly spooked by Facebook’s plans. Among the companies announced to be backing Libra, Visa, Mastercard, Stripe, eBay and PayPal all withdrew from the Association in the months after, citing regulatory concerns that were going unanswered, throwing the future of the project into doubt.

Whether or not Libra ever sees the light of day, it does seem to have spurred a number of central banks to appear proactive about issuing a stablecoin of their own. Added to which, China’s intentions in this area are well known and seem close to fruition.

China has been quietly developing a digital yuan over the last five years, and has tasked some of the largest Chinese companies, such as Alibaba and Tencent, with dispersing the coin to the country’s 1.3 billion citizens.

This probably caused a lot of uneasiness in other countries not least across the South China Sea, where in late January it was reported the Japanese government were speaking of plans to launch a digital yen.

Around the same, a group of central banks including the Bank of Japan, the Bank of England and the European Central Bank announced they were joining forces to examine potential use cases for CBDCs.

We could then be awaiting not just a digital yuan, but a digital yen, a digital pound, a digital euro, a digital krona, and so on, as banks and governments try to avoid uncontested disruption of the global financial system by either a private company or an all-powerful one-party state.

With over 200 privately-developed stablecoins, such as Tether and Gemini coin, there is a case for every fiat currency to have a digital equivalent, not to mention individual institutions developing their own as a cheap and fast means of settlement, JPMorgan's JPM Coin, announced last year, being the obvious example.

A global payments system

This would then present many questions relating to interoperability and the broader economic factors that relate to all currencies.

“We would want to know who is going to establish the exchange or conversion rates,” says Mariana Gomez de la Villa, programme director of DLT at ING.“Which technologies would issue the currency and would this present risk factors?”

Any system used for cross-border payments used by banks and businesses multiple countries would have to meet a high standard with its resilience to cybersecurity threats and other operational risk.

“You would have to consider this in the context of the market and the taxonomy of any specific stablecoin,” Gomez de la Villa adds.

She therefore believes that an international approach is needed to settle on standards that can be widely adopted, but this is at present an unclear journey given how relatively new the technology is. There would need to be a lot of lessons learnt the hard way.

“You can see this even on Ethereum, where they used to have one set of standards for issuing ICOs (initial coin offerings) but they realised this was insufficient,” she says.“That’s how this technology keeps evolving.”

Central banks and other entities may in time realise that their best hope of issuing different stablecoins, that can interoperate easily, is to use a technical infrastructure that already exists, and is known to be a secure and scalable. They may then decide to hold their noses and use the blockchain of an existing cryptocurrency or even turn to Facebook and its partners in the Libra association to do the heavy lifting.

Central banks vs commercial banks

One of the concerns of a private company issuing some form of global digital currency would be the destabilising effects on the broader financial system.

Any money paid for Libra coins, for example, would need to reside in Facebook’s bank account as a guarantor of the value of its digital currency. This money therefore would not be available for loans or mortgages, which would be detrimental to banks who rely on liquidity in order to operate.

A CBDC, by comparison, would cause rather fewer headaches for mainstream financial services companies, though other problems would likely emerge.

Johan Javeus wonders if CBDCs would create an awkward standoff between central banks and commercial banks, which could cause a crisis in the financial system.

If a central bank were to issue a digital currency, any person or company wishing to use it would need to hold some sort of account with said central bank. The central bank would perhaps then be in direct competition with commercial banks to hold people’s cash.

“If everybody were to keep their money in central banks, this could actually destabilise the system as it would drain capital from traditional banks,” Javeus says.

Even if central banks were to store the majority of people and corporates’ money, they would have to start building a separate infrastructure to handle regulatory burdens relating to KYC, AML and so on.

“This would be a huge project for a central bank to undertake,” Javeus states.Again, this points to a requirement for globally-recognised standards and regulatory frameworks that any entity issuing a stablecoin should adhere to.

Stablecoins in a cashless world

Central banks may see this as a task worth undertaking if it helps to address the decline in the use of cash. “Stablecoins could certainly address the decline in cash usage,” Gomez de la Villa says. “For example, in the Nordics and even Holland, usage of cash has declined tremendously.”

Javeus goes into this further, using the example of SEB’s native Sweden, where the Riksbank has become perturbed by this long-term trend.

“The reason why the Swedish Riksbank has taken the initiative to explore the possibilities of a digital currency is because they have seen this alarming decline in the use of cash in Swedish society,” he states.

“Fewer and fewer places of business, retail stores, restaurants and so on are accepting cash as payment today, and that would risk cutting out the central bank when it comes to issuing money.”

Issuing a digital coin would ensure that a central bank’s own currency’s circulation is still healthy even in a cashless world, and prevent consumers turning to the currencies of other countries or even Bitcoin or Ethereum as a means to a fast and frictionless means of payment.

Banking the unbanked

A world without cash would also be detrimental to the many people for whom it is their only means of transacting. The world’s unbanked population is estimated to total 1.7 billion adults. Even in the UK, there are supposedly 1-1.5 million people without a bank account. This is largely constituted of people without proof of identity, proof of address or poor credit history.

These people miss out on the benefits related to utility, mobile and broadband tariffs, because they are unable to pay by direct debit. A study by pre-paid card providerPockit estimated that this amounted to extra costs of £480 a year.

While the majority of day-to-day expenditure and all e-commerce may require use of a bank account, sending a stablecoin or other cryptocurrency requires only an internet connection and a mobile phone.

When the US dollar was the de facto global currency, the US Federal Reserve and by extension the US government held the reins of the world’s financial system. Similarly, those in possession of gold were in an unrivalled position of power when the yellow metal was the world’s economic backstop.

Whichever country can develop and issue a stablecoin that could become the world’s de facto digital currency would be in a similar position.

Mark Zuckerberg admitted to Congress in October that Facebook is “not the ideal messenger right now” to launch a project like Libra, but reiterated that a global payments systems along Libra lines “needs to get built”.

He warned that the US risks surrendering financial leadership of the world if China were to take the lead on this and the yuan was to become the world’s digital currency of choice. 

Stablecoins are a key topic to be discussed at EBAday, the Euro Banking Association's annual conference in partnership with Finextra. European banks, fintechs, and payment providers will gather to explore changes in the industry to develop an open dialogue across key industry players.

Register here for EBAday at The Hague, Netherlands on the 19th-20th May, 2020.