The Last Look…

1:1 or 1:100?

Stablecoins continue to have many doubters, despite the fact that the (current) US government is not one of them. Some of these concerns must be down to the fact that the technology is new and still being tested at scale, but others might arise due to misunderstandings around the functions they could and should perform in financial markets.

Doing away with banks is not one of those functions; just because using stablecoins makes cross-border payments and deliverable FX more efficient, faster, and in many cases multiples cheaper for end-users, it doesn’t mean that these digital tokens have the power or ability to replace banks – what they can do, however, is replace antiquated and VERY obscure technology that simply doesn’t serve end users well.

Stablecoins are not the silver bullet, they’re just an efficient way of transferring value from one point to another. Banks are realising this and this is why they are teaming up to launch new stablecoins with reserves held in the euro and yen. Transferring dollar amounts is already easy and much more transparent than via the correspondent banking system, so it makes sense to turn to tokenising other currencies. Banks have a very defined role in this value movement process and this will remain the case for those that are able to get banking relationships – certainly for institutional investors.

Banks will also very likely perform the on and off-ramping functions that will be necessary for digital value to be converted to fiat and vice versa and while this currently happens at crypto exchanges and brokers, I wouldn’t bet against the people on Wall Street taking over in the future.

But why would a corporate pay its invoices via a bank and pay for currency deals when it can use a dollar stablecoin, or in the future whatever currency they might use in a digital form? This is already happening and it will continue to gain momentum in the future. Equally, why wouldn’t a stablecoin be able to function as a settlement channel between banks and other financial institutions? What’s the risk, apart from those fax machines getting finally thrown out?

And talking of risks, many more banks have imploded over the decades of fractional reserve banking than stablecoins – and not just because the history of the former is that much longer. When depositing funds at a bank there is a guarantee of getting back maybe 20% if the bank goes bust (several unpleasant cases attest to this, with many in recent years – in fact, in recent months jitters about US regional banks introduced a frisson of uncertainty to the party) precisely because of credit creation.

Stablecoins do not create credit and they have their reserves held 1:1 with the amount of tokens in circulation. While they resemble currency pegs, they’re not that because they’re against the same currency – arguing that pegs break would be akin to arguing that sterling will go bust against the pound or that the buck will significantly deviate in value from the greenback.

As for the role of stablecoin issuers, being a one trick pony is far from certain. It’s hard to argue that the role of AI is diminishing. While I’m certainly no programmer, I wager a bet that when AI agents make bookings at the cinema or order an Uber and pay for it online that won’t be with fiat money but stablecoins. Tokenised financial and real-world assets meanwhile, will need a bridge to the fiat world, a role that stablecoins will be more than able to play.

Central bank digital currencies aren’t a risk either, they’re instead the extension of the digital opportunity. This is because central banks that are working on CBDC projects are very much focusing on wholesale versions, exploring the benefits of an alternative settlement system for their respective financial ecosystems. Stablecoins and CBDCs therefore can very much exist alongside each other, as the UAE will show soon.

To summarise a couple of key points around risks: Stablecoins are only as risky as the institutions that hold their reserves; de-pegging can only happen if either the bank holding the reserves goes bust due to the fractional reserve banking model or if the value of government debt spirals; CBDCs and stablecoins will be interoperable rather than mutually exclusive.

And finally, stablecoins perform a function that will allow banks to become more efficient and (probably) to make more money as a result. What is in danger are systems that should have evolved with the market but didn’t, or ones that benefit from the status quo. I suspect in the end hedge funds and institutional investors will vote with their feet in what they use and how, and so will those that serve them.

History doesn’t repeat itself, but it certainly tends to reward those that embrace change and that often means technology. Let the better one win!