A visual representation of digital currencies.
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Virtual payments can be costly and slow – which makes them ripe for disruption by digital currencies, particularly stablecoin.
What makes virtual payments inefficient is that they occur in a multitude of smaller closed networks: banks facilitate transfers linked to accounts, credit card networks enable payments on credit, and payment processing firms like PayPal offer payments within their own ecosystem.
Since these transactions require a middleman to facilitate them, they can become expensive, slow and restrictive. McKinsey estimates the financial system makes $2 trillion annually from facilitating payments. This is exactly what the pseudonymous Satoshi Nakamoto proposed to solve when he released the initial whitepaper for “Bitcoin: A Peer-to-Peer Electronic Cash System.” With the advent of bitcoin, a virtual payment network was created that had the same properties as cash. Anyone can join the bitcoin network, start to accept bitcoin, as well as spend it freely. There is no gatekeeper in control of the network.
While bitcoin has become enormously successful measured by its price appreciation, its payments use case has been constrained due to its volatility. However, bitcoin, the original blockchain, has sparked a host of initiatives to facilitate digital cash payments.
A popular approach is using stablecoins, which are cryptocurrencies pegged to an underlying asset, usually the U.S. dollar. At the time of writing approximately $100 billion worth of stablecoins has been issued on public blockchain networks. These stablecoins are freely transferable just like cash; anyone on the blockchain network can receive and send the coins. The coins are structured as bearer instruments, giving the holder the rights to redeem the coins for U.S. dollars at any time.
So far, all stablecoins have been issued by private parties. Inspired by the advances of private players in the field, including Facebook’s interest in launching its Libra coin (now called Diem), central banks have started accelerating their own stablecoin initiatives, with two-thirds of the largest central banks currently experimenting in the field. The core difference between central bank backed digital currencies (CBDC) and privately issued stablecoins is that the former presents a direct claim against the central bank, while the latter are a claim against the issuer. CBDCs are therefore considered a safer option.
But there is a problem with central bank digital currencies. Not only are they safer than other stablecoins, but they are also likely to be perceived as safer than any bank deposits. Why hold money at a bank, which can always run out of money, when you can hold it at the facility in control of the money itself? That can quickly put the whole banking system at risk.
It seems likely that CBDCs will only be made available in limited quantities to the public, creating “space” for privately issued stablecoins, which are able to solve a lot of the problems in payments today. Public blockchains are open, allowing everyone to participate in the system. They facilitate near instant settlement of payment and, with liquid stablecoin markets, swapping between different stablecoins becomes almost frictionless.
Private stablecoins allow payers to get as close to the benefits of cash as possible. As such, it is no surprise that the global demand for these has grown from $28 billion issued at the beginning of 2021 to $109 billion issued today, an almost four-times increase in just six months.
The first stablecoin, Tether, grew out of the need for cryptocurrency exchanges to hold balances in U.S. dollars while having trouble obtaining a bank account. As such, Tether is still used to facilitate cryptocurrency trading. Tether remains an obscure coin with uncertainty about full backing, which has led to a range…