Stablecoins: Why They Exist and What They Can Do For You RazeTeam January 18, 2024

Stablecoins: Why They Exist and What They Can Do For You

In recent years, there has been a buzz about stablecoins and their potential to revolutionize the world of payments. In this blog post, we’ll break down the concept in a non-technical way, exploring their current use cases, growth opportunities, and how they might impact the traditional banking system.

Stablecoins: What Are They?

Stablecoins are a type of cryptocurrency designed – as the name says – to be stable in value. One of the criticisms for digital assets like Bitcoin is that they are too volatile to be beneficial for transferring money because if you are trying to settle a contract with Bitcoin, its value could drastically change within a short period, making the transaction unpredictable and potentially unfair for one of the parties involved. This volatility is primarily due to factors, including market speculation, varying liquidity levels across exchanges, and sensitivity to regulatory news and developments in the crypto ecosystem.

On the other hand, stablecoins could be a solution to this pain point. Just as the name implies, Stablecoins are designed to maintain a stable value. This stability offers a major advantage for transactions and contract settlements:

Predictability: With a stable value, stablecoins provide predictability in transactions. Parties in a contract can agree on a value without worrying about unexpected fluctuations common with assets like Bitcoin.

Reduced Risk: The reduced volatility of stablecoins mitigates the risk of financial loss between the time of agreeing on a transaction and the time of settlement.

Facilitates Planning: Businesses and individuals can plan their finances more effectively when the currency involved doesn’t fluctuate wildly.

Wider Acceptance: The stability of these coins could lead to broader acceptance in everyday transactions, including in the traditional financial system.

Regulatory Compliance: Users of stablecoins, especially those pegged to fiat currencies, may find it easier to comply with existing financial regulations, making them more palatable to regulators and financial institutions.

In order to maintain stability, these stablecoins are often pegged to a traditional currency like the US dollar. Unlike more volatile, unpegged cryptocurrencies like Bitcoin, stablecoins aim to provide a reliable and secure means of transferring value. Because of their unique value proposition, stablecoins can bridge the traditional financial system and the new decentralized financial system evolving right before our eyes.

In the past year, the amount of wallets holding stablecoins has skyrocketed. Because of this explosive growth, there is more attention than ever on stablecoins, which have recently attracted more attention from regulators, policymakers, and those within the traditional finance ecosystem.

Current Uses and Growth Prospects

Stablecoins are gaining popularity for various reasons. They offer a way to transfer funds quickly and efficiently across borders, potentially reducing the need for traditional banks and expensive wire transfers. This feature alone makes them attractive for international transactions and remittances. 

Because the financial world and the infrastructure of money management were created well before the advent of the internet or computers, there are processes in place around cash transfers and payments that are frustratingly burdensome and time-inefficient in our global economy. The adoption of stablecoins as a tool for traditional finance can help bring monetary transactions of any kind into the twenty-first century without the volatility of prices in other cryptocurrencies.

Stablecoins are not just another digital asset. They’re changing how we think about money and banking. They offer a stable value in the often volatile world of cryptocurrencies and enable quick, secure transactions without the need for traditional banking systems. Plus, they’re accessible 24/7, making them super convenient. Because of this, stablecoins have caught the attention of policymakers, regulators, and more of the TradFi world.  For a more technical deep dive, check out this white paper released by the Board of Governors of the Federal Reserve

One big question is how stablecoins will affect the traditional role of banks in lending money. Interestingly, there has been recent adoption of the idea that stablecoins could coexist with traditional banking, potentially even boosting credit provision. However, if stablecoins are required to be fully backed by central bank reserves (the “narrow bank” model below), there could be a downside for credit intermediation.

The features of stablecoins, like their security and programmability, open the door to innovations in payment systems and financial markets. As the use cases of stablecoins evolve and as more and more industries adopt them into their ecosystems, we’re likely to see more inclusive financial systems, tokenized financial markets, and even microtransactions made possible thanks to stablecoins.

Impact on Traditional Banking

As the Fed points out in the paper referenced above, the impact of stablecoin adoption on traditional banking can take different forms, depending on where the money comes from and what backs these stablecoins.

Two-Tiered Banking System

In this model, stablecoins coexist with traditional banks. They can be issued and used alongside regular currencies, allowing for faster and more cost-effective transactions. This approach maintains the familiar structures of credit creation through banks.

Narrow Bank Approach

On the other hand, some propose a narrow bank approach, where digital currencies take center stage, potentially sidelining traditional banks. While this might lead to less reliance on traditional banking, it can provide a more stable value linked to fiat currencies.

Tokenization & Stablecoins

At Raze, we’re particularly interested in the role that stablecoins will have in the world of tokenization. As more and more parts of the global economy are benefiting from blockchain technology, tokenization is where we see this trend heading, and we’re excited to be on the cutting edge. 

As Gordon Liao and John Caramichael write in the above-referenced paper, “A tokenized market would allow for real-time settlement at very low costs. This could increase liquidity, transaction speeds, and transparency while reducing counterparty risk, trading costs, and other barriers to market participation.” This makes room for fractional ownership of tokenized assets and near-instantaneous payments that are notorious for taking upwards of three days in a traditional financial framework. 

Stablecoins and tokenization complement each other in the evolving digital asset landscape. Stablecoins provide a trustworthy and stable medium of exchange that can facilitate transactions in tokenized markets, enhancing liquidity, efficiency, and accessibility.

Stability in Turbulent Times & Potential Issues

One intriguing aspect of stablecoins is their potential to act as a digital safe haven currency during periods of cryptocurrency market turbulence. Stablecoins pegged to the US dollar and backed by secure and liquid assets can offer stability when other cryptocurrencies experience wild price swings and can offer the best of both worlds.

Stablecoins could reshape traditional banking in significant ways. If more people start using stablecoins, banks, policymakers, and regulators will need to rethink how they adopt the new technologies. Some scenarios suggest that stablecoins could enhance credit creation, while others warn of potential risks. 

As stablecoins grow, concerns arise about their stability, consumer protection, and compliance with financial regulations. In particular, the trust that has been instilled in stablecoins will erode if they cannot maintain their stability. In this article from November 2023, Moody’s quotes Yiannis Giokas, Senior Director, Product Innovation at Moody’s Analytics, as saying, “We have seen the stablecoin market grow into a multibillion dollar asset class accounting for about 10 percent of the crypto market and most on-chain activity,” but the article goes on to discuss a key concern within the stablecoin market – instability. The good news is the number of times when a pegged stablecoin has drifted away from the pegged currency has fallen since the year before, but stablecoins must demonstrate consistent and reliable stability if they are to be adopted more and more broadly.

Conclusion

The world of payments is evolving rapidly, and stablecoins are at the forefront of this transformation. They offer reliability, speed, and a much-needed bridge between traditional and decentralized finance. Whether they coexist with banks in a two-tiered system or lead to a more narrow banking approach, stablecoins are set to significantly impact how we handle money in the future. Keep an eye on this space and what opportunities they unlock within the world of tokenization as we witness the evolution of payments in real time.

About Raze Fintech Inc.

Raze is a disruptive operating system that significantly reduces the cost of raising capital acquisition for startups while substantially increasing transparency, access, automated compliance, and efficiency for investors. Startups and existing businesses can design, set up, and deploy their raise using equity, debt, and revenue financing to qualified investors.

For more information, please visit: raze.finance

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