Stablecoins’ Role in International Relations
As financial institutions across the world, such as the European Central Bank, begin to seriously consider cryptocurrency as a legitimate asset class and payment system, conversations about regulations are bound to increase.
As one of the most fear-provoking aspects of digital currencies is their volatility, stablecoins have arisen as a possible alternative. Stablecoins are inherently opposite to Bitcoin, Ethereum, and others, while providing many of the same benefits by existing on the blockchain.
What are Stablecoins?
Stablecoins are a type of crypto whose value is pegged to and/or is backed by a fiat currency or another asset class, such as gold. For example, UST, USDT, and USDC are all worth 1 US Dollar. As opposed to other coins, they aim to be a stable cryptocurrency that eliminates the volatility of other digital currencies.
Stablecoins can then be divided into two categories: centralized and decentralized. Centralized stablecoins are issued by private companies and are usually collateralized by fiat or other non-digital assets off-chain. For instance, the company Circle is the issuer of USDC. Much like governments, they have the ability to adjust their supply manually by minting or burning when needed.
Decentralized stablecoins have full transparency and are non-custodial. This means that no one person can control them since they employ smart contracts to increase or decrease their supply. All of their collateral backings are public, just like any other cryptocurrency on the blockchain.
Did you know: One of the best things about stablecoins is that you can stake them on centralized exchanges to earn an incredible interest rate? In fact, you can stake GUSD on Gemini to earn more than 8% interest!
What are the Risks Associated with Stablecoins?
Proof of Reserve
Despite lacking the volatility of Bitcoin and other types of cryptos, stablecoins still present one major risk that retail investors should be aware of.
Proof of reserve is the way digital custodians demonstrate that they actually hold the funds they claim to hold for their investors. In the case of stablecoins that are, in theory, redeemable for a particular real-world coin, this would involve the company proving that they have their tokens backed or collateralized by the correct amount of assets.
However, the stablecoin market has not always excelled at demonstrating proof of reserves. In fact, most stablecoin issuers have not been transparent when it comes to disclosing the status of their reserves, failing to provide reliable audits.
The most notorious case is Tether (USDT), which, apart from being the third-largest crypto by market cap, is also one of the most criticised projects (if you ask Reddit or Crypto Twitter). In the past, Tether had claimed that it had $1 in reserve to back all of its tokens. Yet, in 2019, it was discovered that they had cash and equivalents (short term securities) totalling around $2.1 billion, which represented approximately only 74% of the USDT in circulation.
In 2021, Tether released its full reserve breakdown for the first time. Investors were surprised to see that a significant percentage was held in commercial paper, a form of unsecured, short-term debt often issued by companies, and corporate bonds.
A new fiat-backed stablecoin, True USD, has aimed to fix the transparency issue in the market. They hold their US dollar collaterals in multiple trust companies’ accounts that are published every day and are subject to monthly audits.
Can Stablecoins Hold their Peg?
Concerns about the reserves backing stablecoins inevitably lead investors to question whether the tokens can keep their peg to the real-world asset they represent.
In the case of a coin like USDT, it holds a large number of corporate bonds. But what would happen if the companies who issued the bonds defaulted on their debt and those assets fell in value due to a market crash?
Would investors be able to redeem their stablecoins for dollars? This is a question that many crypto analysts have often posed. In the worst-case scenario, it could trigger a bank run as all holders try to cash out at the same time, making the token issuer unable to process the request, which would reduce the price even further. This is akin to what has happened during other tumultuous economic periods, such as the 2008 global financial crisis.
What are the Potential Benefits of Stablecoins?
Unlike other cryptocurrencies, stablecoins are not volatile and do a good job of holding their peg. As such, they are an excellent way to send money and exchange it for goods and services. For instance, if a country like Mexico wanted to sell its agricultural products to the United States, it could do so without having to worry about the price fluctuating before and after the transaction.
Speed and Price
Transactions can take less than a minute on the Ethereum network and mere seconds on faster blockchains, such as Avalanche and Solana. In addition, gas fees on most chains other than Ethereum are far less than $1, making it inexpensive to send significant amounts of money to people anywhere in the world. International trade could stand to increase from stablecoins’ lower fees and faster transaction speeds as well.
With stablecoins, nations would not have to rely on wire or SWIFT transfers, which are slow and costly.
Ease of use and access
Accessing and using stablecoins is easy. With banks, you require a lot of information to send a transaction or even open an account. With stablecoins on the blockchain, the only thing you need is a wallet.
What’s more, many low-income countries lack an appropriate banking system. Easy access through the internet and the stability of USDC and others could potentially bolster greater financial inclusion.
What Role do Central Bank Digital Currencies play?
What are CBDCs?
A central bank digital currency (CBDC) is a country’s currency but in a digital format. A CBDC is issued, regulated, and fully backed by central banks, like the United States Federal Reserve. CBDCs run on centralized blockchains where governments maintain complete control of the network.
To learn more about CBDCs, check out our recent article where we did a deep dive on the topic.
Stablecoins Will Probably Not be Used in International Relations
As the Financial Stability Oversight Council outlined in their 2021 Annual Report, the possibility that some stablecoins might not be fully backed or are unable to maintain a peg presented two major issues.
In our opinion, these aspects will likely stand in the way of stablecoins being adopted as the de facto medium for transactions in international relations. For thousands of years, governments have preferred currencies that they can fully control and stablecoins do not provide this opportunity.
National authorities in major economies are taking steps to regulate stablecoin use to minimize any of their suspected downsides. For example, in the EU, there is a European Commission proposal for a regulation on markets in crypto-assets, which was adopted in September 2020 and is currently under review by the European Parliament and the Council.
However, despite governments considering digital currencies to reduce the inefficiencies of the traditional financial system, they are more likely to adopt CBDCs, which they create and regulate, instead of stablecoins.
Coin Clarity’s Thoughts on Stablecoins in International Relations
Stablecoins are an excellent way to improve the current financial system and framework. They expand the capacity to send payments at a cheaper rate and faster speeds. Opposite to what their name would indicate, these assets are not without their risks, such as security. These risks will probably stand in the way of them being fully adopted in international relations by governments and regulators. Instead, CBDCs will be preferred.
That said, at Coin Clarity, we do not see stablecoins disappearing anytime soon. Given the protection that a centralized exchange provides for using them, we recommend using one, like Gemini or Binance, to stake your crypto and earn passive income on your GUSD, USDC, and others.