Are stablecoins a blessing or a curse for underdeveloped economies?
Author | Anastasia Melachrinos, Christian Pfister
first level title
01 Classification and representation of stable coins
Stablecoins can be defined as cryptoassets designed to maintain a stable price relative to a benchmark, usually provided by a fiat currency, sometimes by a basket of currencies, a commodity such as gold, or even another cryptoasset. By using stablecoins, crypto asset investors are able to stay in the crypto world and gain advantages in terms of resiliency, integration, immutability and anonymity, while benefiting from the stable environment usually borrowed from fiat currencies.
Stablecoins can also enable arbitrage between cryptoassets while maintaining a link to an investor’s reference currency and avoiding the regulatory constraints and costs associated with converting between cryptoassets and fiat currencies (transaction fees, often illiquidity, price large fluctuations, etc.). Therefore, stablecoins are designed to serve as tools in the world of crypto assets.
Stablecoins seem to offer a brave new world. From this perspective, stablecoins would be the next natural step in the evolution of digital assets if their stability promises are fulfilled.
Stablecoins can be defined in four complementary ways:
1) According to the price guarantee mechanism: the goal of the convergence of the stablecoin to its benchmark is ensured by the governance system that implements rules to stabilize the value of the stablecoin and the entity responsible for managing the stability mechanism. From this, stablecoins can be divided into algorithmic stablecoins, off-chain guaranteed stablecoins, and on-chain guaranteed stablecoins.
2) Based on whether stablecoins are potentially systemic: This approach is that adopted by the G7 Working Group on Stablecoins and is particularly relevant when assessing risks to macroeconomic stability. According to this distinction, while all stablecoins are risky, those built on a large customer base and/or cross-border have the potential to scale rapidly and achieve a sizable global footprint.
3) According to the target market, it can be divided into wholesale (large transactions, usually between financial institutions or between financial institutions and large companies) or retail (large-scale transactions between individuals or between individuals and merchants) stable coins. This distinction mirrors the difference between the two forms of central bank digital currency, a wholesale CBDC aimed at financial institutions, and a retail CBDC aimed at the general public.
4) Depending on the base currency, stablecoins may be unique (usually USD) or constitute a basket as envisioned by the promoters of the Libra (now Diem) initiative.
Given their volatile prices, low volume, limited circulation, and concentrated market, stablecoins appear to have had mixed success, and markets for them have so far emerged as ancillary to cryptoassets.
Most importantly, the arrival of large players issuing off-chain guaranteed stablecoins with the potential to reach a broad audience can provide stablecoin users with additional confidence and potential systemic impact for their projects.
Among wholesale stablecoin projects, two of the largest stand out: the USC (Utility Settlement Coin) project and JPM Coin。
USC is an initiative led by major banks to create a market infrastructure for cross-border payments that is often costly, time-consuming and opaque today to meet recommendations from various regulators. Circulating on a permissioned blockchain, the stablecoin will be issued in different reference currencies and fully backed by reserves held by the central banks (CAD, EUR, GBP, JPY and USD) that issue these reference currencies, in principle It becomes possible to guarantee the convertibility of these fiat currencies.
The main contribution of the project is to provide users with the possibility of almost instant settlement at the global level at any time of the year - saving each currency represented by liquidity by holding only one liquidity pool at the global level, while Instead of limiting several pools with different correspondent banks based on time zone.
The JPMorgan project is similar in terms of technology employed (permissioned blockchain) and purpose (real-time money transfers at the institutional level, 365/24). It differs from USC's in two important ways: in the current state of the project, the only reference currency is the U.S. dollar,On top of that, the guarantee will consist of JP Morgan deposits, not central bank reserves, subject to liquidity and credit risks。
JPM Coin aims to reduce friction in the USD currency market by facilitating the settlement of transactions between different clients. Another situation where JPM Coin could be used is in the repo market, where it can be extended to intraday maturities, allowing collateral to be released by ensuring a faster turnover rate.
Among the retail stablecoin projects, the most famous is Diem, whose issuance and governance are intended to be overseen by the Diem Association, which verifies that transactions made are on a permissioned blockchain. Other private players are also part of the association, such as Vodafone, Coinbase, Spotify, Uber, etc.
In the latest white paper, the association proposes two classes of tokens:
1) A multi-currency stablecoin presented as a global currency. Diem will be backed by a stablecoin-only basket, which will ensure its stability by investing assets raised by issuing Diem in a pool of low-volatility assets, including stablecoin-denominated bank deposits and government securities. More precisely, the reserve would consist of at least 80% short-term government bonds issued by sovereigns with very low credit risk, with the remainder in cash.
2) Stablecoins based on a single currency “will enable a range of domestic use cases by enabling people and businesses to transact in stablecoins denominated in their own currency.” Each currency will be backed by the aforementioned reserve system.
Compared with other encrypted assets, wholesale stablecoins can facilitate the integration of financial transactions on the blockchain and reduce friction in cross-border payments; similarly, retail stablecoins can reduce remittance costs and promote financial inclusion in emerging countries; , a basket of stablecoins could reduce the dominance of the U.S. dollar in international transactions and the resulting external adjustment difficulties for emerging economies; finally, in emerging or developing economies, especially those experiencing currency instability or suffering from structural In economies affected by high inflation, a basket of stablecoins could serve as an alternative to fiat currencies, especially as a store of value.
first level title
02 Risks of Stablecoins
There are inherent risks with any stablecoin, including:
1) legal certainty, especially with regard to the rights of users;
2) Governance, which allows clear assignment of responsibilities, especially with regard to risk review and control;
3) financial integrity to prevent stablecoins from funding illicit activities;
4) Regulatory arbitrage, while the regulatory framework is designed to be applicable to the technology used;
5) Market integrity, as the pricing of services provided, must be fair and transparent, starting with stable prices, to protect consumers and ensure a level playing field;
6) Data protection, as users need to know how their data is being used by participants in the ecosystem surrounding the issuing blockchain and possibly third parties;
7) Consumer/investor protection, as the risks and obligations of the parties must be clearly defined and defined;
8) Compliance with tax requirements, as stablecoins should not provide a tool for fraud;
In principle, these risks are only possible in economies with low confidence in fiat currencies, limited supply of financial products, problems with the health of financial intermediaries or payment systems. Therefore, these countries tend to be less developed economies and possibly emerging economies.
A particularly serious risk is the substitution of stablecoins for fiat currencies, which could lead to stablecoin issuers making them self-referential currencies. These issuers would then become central banks in the realm of private money: this is the theme of the "loss of monetary sovereignty". For these two risks, a distinction is made between wholesale and retail stablecoins.
financial stability risk
For wholesale stablecoins, there are some risks that could jeopardize financial stability. Those JPM Coins that are not backed by central bank deposits are subject to credit risk. Additionally, the centralization of financial transactions in the blockchain will strengthen the global linkages of large financial institutions and large corporations, creating single points of failure and too-big-to-fail moral hazard issues in the case of systemic stablecoins.
For retail stablecoins, the feasibility of its business model largely depends on the interest rate level of the assets held. If the stablecoin is 100% backed and the reserves are invested in assets denominated in currencies such as dollars, euros or yen, today’s historically low interest rate levels significantly limit the returns on reserves.
Therefore, in order to maintain profitability, issuers may be tempted to invest in securities that are riskier in terms of credit, liquidity, swaps, or even exchange rates, even if the latter strategy does not replicate the composition of the basket. In the case of a basket of stablecoins, it could even in principle change the composition of the basket.
From a holder’s perspective, what are the financial implications for stablecoin users if the issuer defaults or ceases operations? To the best of investors' knowledge, these risks are reflected in the discount of issued units relative to the benchmark, which could lead to a crisis of confidence as well as a run.
For on-chain guaranteed stablecoins, failure of investors to meet margin calls could also lead to a run if the price of the crypto asset falls sharply, although the issuer may choose to liquidate the positions of defaulting investors.
monetary policy risk
Stablecoins may have a much greater impact on the behavior of monetary policy than cryptoassets.
In the case of wholesale stablecoins, their issuance may result in a reduced demand for reference currency reserves. This is especially the case if the wholesale stablecoin envisioned by JPM Coin is not backed by central bank deposits as USC envisions.
This is because the closing of transactions previously on the central bank’s books, such as the settlement of cleared balances, can be transferred to the wholesale stablecoin’s blockchain. One consequence is that, in the event of a liquidity crisis affecting money markets, the central bank's less detailed knowledge of institutional cash holdings could make it more difficult for it to intervene as a lender of last resort.
On the other hand, if a wholesale stablecoin is fully or mostly backed by the base currency, the demand for reserves could increase significantly and become more volatile, depending on the liquidity needs of stablecoin users. In this regard, since wholesale stablecoins should always be available, cash pressures could affect wholesale stablecoins backed by central bank money outside of the issuing central bank’s business hours, exposing their holders to liquidity risk. However, this problem can be solved by moving to real-time monetary policy.
In the case of retail stablecoins, their widespread use could lead to crowding out of fiat currencies, making monetary policy difficult in terms of transmission mechanisms and implementation:
1）Transmission mechanism, which can be subdivided into interest rate channel, credit channel and asset price channel. The conversion of bank deposits into stablecoins and the eventual distribution of stablecoin-denominated loans would weaken the transmission of changes in fiat currency interest rates to the economy. For example, if this interest rate rises, the incentive to save and the incentive to take on debt will weaken, and thus the contractionary impact on the economy will be weakened.
On the other hand, credit access will be affected by ambiguity. A narrower channel could be weakened, as the banking sector's liquidity would be at least partially in stablecoins, and thus would not be directly influenced by central banks unless they intervene in stablecoins themselves. Conversely, if the substitutability between stablecoins and fiat-tender financing is lower than that of different forms of fiat-tender financing, increased financial friction strengthens broad channels. Finally, as long as fiat currencies continue to be used as the unit of account, the asset price channel becomes stronger because the effect of interest rates on exchange rates will affect a larger proportion of assets.
Overall, the impact on the transmission mechanism will be ambiguous and may be characterized more by greater uncertainty about the effects of monetary policy, which in turn could justify further gradualism rather than diminish its power .
2) Implementation ability. As long as fiat currencies continue to be used, there will be market demand for base money, and it should still be possible to implement monetary policy, but propose a model where digital currencies compete with non-competitive national currencies, leading to a complete convergence of interest rates between them, thus Deprives the central bank of the ability to adjust monetary policy to its economic conditions.
However,
However,In addition to reducing the cost of international transfers and promoting financial inclusion in emerging markets, stablecoins can also bring benefits and remove the bad by increasing choice of trading and investment vehicles, intensifying currency competition by allowing benign currencies to drive currency competition, and Constrain monetary policy when appropriatefirst level title
03 Reactions from all walks of life
private sector response
Stablecoins are deployed in environments driven by two currents: the assumed supply capacity enhanced by the underlying technology, and changes in demand or consumer preferences in the target market. This perfectly applies to stablecoins. However, players in the payments industry, especially banks, can rise to the challenge by improving the quality of services they provide.
In this regard, one of the most radical shifts in recent years has been the commoditization of instant payments. This is particularly evident in China, where the two giants Alipay and WeChat Pay accounted for 92% of the $41 trillion mobile payments market in 2018. In China, due in part to competition from Alipay and WeChat, banks' ROE fell by 35 basis points in both years (2015 and 2016), bringing their ROE down by 6.7%.
Faced with the threat of disruption to their businesses, banks in the US, Europe and Australia are responding first by digitizing some of their operations, with some 15 to 25 percent of their annual budgets allocated to information technology. 2016. In France, major banks have teamed up to create PayLib entre amis, a system that allows users to identify themselves with their phone number and make instant payments with other users through the bank's online platform.
At European level, TARGET 2 has been a real-time gross settlement (RTGS) system developed and administered by the Eurosystem since 2008, with each country administering its national portion. In November 2018, to facilitate the full rollout of instant payments in Europe, the Eurosystem launched within TARGET2 a system for instant payment settlement in central bank currency, the TARGET Instant Payment Settlement (TIPS) service.
The new service runs 24/7/365 and is available at 0.20 cents per transaction for at least the first two years of operation, with entry and maintenance fees for TIPS accounts set at zero and with the aim that the Eurosystem will eventually be fully pay for this. However, more than a year after the initiative, instant payments are still not widespread in the euro zone, mainly because of their cost to users.
At a global level, facing inefficiencies in the correspondent banking system, central banks issuing major reserve currencies could interconnect their real-time gross settlement systems to facilitate cross-border payments. The initiative will partly compete with and partly complement wholesale global stablecoin initiatives, extending their operations to the country or currency area level.
In fact, real-time gross settlement systems are intended to provide a secure framework for the final settlement of wholesale transactions, in particular through the use of central bank money; moreover, they compete to some extent with privately run settlement cost. By interconnecting real-time gross settlement systems, central banks will largely avoid the need for payment service providers to use correspondent banking arrangements, allowing them to conserve liquidity and provide customers with more reliable, faster and possibly cheaper settlement of international transactions.
Regulators' Response
"Same business, same risk, same rules" and consistent regulatory approaches across countries constitute the regulatory guidelines proposed by the G7 Global Stablecoin Working Group. Following the latter's work, the G20 in June 2019 mandated the Financial Stability Board (FSB) to review the regulatory issues raised by the global stablecoin arrangement and to make recommendations on a multilateral response. Therefore, the first response of regulators is to coordinate to avoid regulatory arbitrage.
Regulators must also consider the legal classification of stablecoins, however, as regulation varies depending on the nature of the underlying asset (e.g. currency or security). In particular, there are multiple options for the most common off-chain guaranteed stablecoins.
The first is to think of them as money market funds, since they invest in principle in low-risk, short-term assets denominated in the currency they back, with the aim of maintaining a constant value, as each unit issued can be stable even in a basket In the case of currency, it is also assimilated into money market fund units.
The second option is to consider stablecoins as electronic money, on the grounds that stablecoins are intended to be used as payment instruments and their issuers promise to redeem them at par. The second condition is much more restrictive on issuers than the first condition, e.g. in Europe, the 2009 European Electronic Money Directive includes capital requirements and an obligation for issuers to be able to redeem holders at par at any time .
Current regulations applicable to traditional financial or payment instruments still do not address the multiple risks posed by stablecoins, thus requiring regulatory adjustments:
1) The widespread use of global stablecoins may be accompanied by their use for money laundering and terrorist financing purposes, which is in violation of LCB-FT regulations. In fact, Libra users can conduct transactions anonymously in order to protect their privacy, which is inconsistent with regulatory compliance;
2) Regulators could consider the above financial stability risks, including the risk of a liquidity crisis, by imposing prudential requirements on stablecoins;
3) Regulators may also consider protecting data from commercial exploitation by issuers. A number of concerns have been raised about Diem's use of the data;
4) Finally, regulators can ensure that the blockchains used by stablecoins are operationally resilient. In fact, blockchain scalability to the number of recorded transactions is uncertain. It is within this framework that the Diem project foresees, in order to avoid possible congestion, a tariff increase according to Diem demand, in order to reduce this demand and avoid congestion.
Faced with this measure, the regulator could introduce insurance for customers regarding the maximum time limit for transferring their applications. In addition, in the event of a cyber attack or blockchain hack, the procedures in place for stablecoin holders to limit risk should be clearly explained, with provisions for compensating legitimate holders.
On September 24, 2020, the European Commission published a proposal for the regulation of the crypto asset market. Under the proposal, all crypto asset issuers would be required to publish white papers, and members of their governing bodies would have to meet integrity standards. Compliance with these requirements will be monitored by national authorities or the European Banking Authority.
Additionally, all crypto asset service providers must have a physical presence in the EU and be subject to prior authorization from national authorities. This would allow them to obtain a "European passport" (i.e. potentially offer their services throughout the EU), but would eliminate off-chain stablecoins without an identifiable issuer. Finally, crypto asset service providers will also be subject to capital requirements, governance standards and the obligation to keep client assets separate from their own.
Responses from central banks
Both measures are possible, depending on whether they are defensive (central banks adapt their policies and tools to the new environment brought about by the expansion of global stablecoins) or offensive (central banks come up with their own solutions to compete with global stablecoin competition).
On the defensive level, emerging countries already frequently impose foreign exchange controls and can treat stablecoins as if they were foreign currencies. At an international level, this requires coordination by the central bank and all regulators and is a minimal response. The G7 does this because stablecoins are global in nature and to avoid regulatory arbitrage;
On the offensive level, central banks could issue CBDCs to counter stablecoins. However, this could create difficulties for their banking sector, whose resources would be affected by CBDC alternative deposits. Furthermore, it is uncertain whether this would adequately address the risk of retail stablecoins marginalizing national currencies due to inefficiencies in their operation to fiat currencies, national financial systems, or domestic payments.
