Opinion: The Rise of Stablecoins in the Race for Digital Money

A battle rages on for your wallet. New entrants want to occupy the space once used by paper bills or your debit card.

The adoption of new forms of money will depend on their attractiveness as a store of value and a means of payment. Stablecoins, however, are very different from popular incumbents: cash or bank deposits.

While many stablecoins continue to be claims on the issuing institution or its underlying assets, and many also offer repayment guarantees at face value (a coin purchased for 10 euros can be exchanged for a banknote of 10 euros, like a bank account), the government support is absent. Trust must be generated privately by backing coin issuance with safe and liquid assets. And settlement technology is generally decentralized, based on the blockchain model.

The times are changing. USD Coin recently launched in 85 countries, Facebook announced Libra, and centralized variants of the stablecoin business model are becoming more widespread. So why are stablecoins taking off?

The strength of stablecoins is their attractiveness as a means of payment. Low costs, global reach, and speed are all huge potential benefits. Additionally, stablecoins could enable transparent blockchain-based asset payments and can be integrated into digital applications thanks to their open architecture, as opposed to banks’ proprietary legacy systems.

But the strongest pull comes from the networks that promise to make transactions as easy as using social media. Payments are more than just transferring money. They are a fundamentally social experience that connects people. Stablecoins offer the potential for better integration into our digital lives and are designed by companies that thrive on a user-centric design. Large tech companies with huge global user bases offer an out-of-the-box network over which new payment services can spread quickly.

However, the risks associated with stablecoins abound – so policymakers need to create an environment that minimizes them while maximizing their benefits. Policymakers will need to innovate and collaborate across countries, but also across functions. Here are six observations to consider.

First, banks can lose their place as middlemen if they lose deposits to stablecoin providers. But banks are not sitting ducks. They will surely try to compete by offering their own innovations (and higher interest rates). Additionally, stablecoin providers could recycle their funds back into the banking system or decide to engage in loans by extending deposits themselves. In short, the banks are unlikely to disappear.

Second, new monopolies could emerge. Tech giants could use their networks to exclude their competitors and monetize information, using exclusive access to data on customer transactions. New standards are needed for data protection, portability, control and ownership. And services must be interoperable to facilitate entry.

Third, weaker currencies could be at risk. In countries with high inflation and weak institutions, local currencies could be avoided in favor of stablecoins in foreign currencies. It would be a new form of “dollarization” and could undermine monetary policy, financial development and economic growth. As countries are forced to improve their monetary and fiscal policies, they will have to decide whether to restrict stablecoins in foreign currencies.

Fourth, stablecoins could promote illicit activities. Suppliers must demonstrate how they will prevent the use of their networks for activities such as money laundering and terrorist financing by applying international standards. New technologies offer opportunities to improve supervision, but supervisors will need to adapt to the more fragmented and geographically diverse value chain of stablecoins.

Fifth, stablecoins could cause the loss of “seigniorage,” where central banks capture the profits from the difference between a currency’s face value and its cost of manufacture. Issuers could siphon off their profits if their stablecoins do not bear interest, but if the hard currency backing them generates a return. One way to solve this problem is to promote competition so that coin issuers eventually pay interest.

Sixth, policymakers must strengthen consumer protection and financial stability. Client funds need to be safe and protected from bank runs. This requires legal clarity on the type of financial instruments that stablecoins represent. One approach would be to regulate stablecoins like money market funds that guarantee fixed nominal returns, requiring providers to maintain sufficient liquidity and capital.

Stable coins therefore present as many puzzles as there are potential benefits – and policymakers would be wise to consider far-sighted regulatory regimes that will meet the challenge. The policies adopted today will shape the world of tomorrow.

Tobias Adrian is Director of Monetary and Capital Markets at the IMF, and Tommaso Mancini-Griffoli is Deputy Head of the Department. This opinion piece first appeared on IMFBlog.

Contact publisher Lu Zhenhua ([email protected])

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