Stablecoins have experienced tremendous growth with at least a 500% increase in adoption from just a year ago. While the responsibility for this growth can be mostly attributed to a few use cases, there are many others still in their early stages of development that provide innovative solutions around consumer payments. As these payment use cases mature, we could see user adoption of stablecoins continue to grow at exponential rates. In this note we will discuss these use cases and the benefits they provide.
The US treasury defines a stablecoin as a category of cryptocurrencies with mechanisms that are aimed at maintaining a stable value, such as by pegging the value of the coin to a specific currency, asset, or pool of assets or by algorithmically controlling supply in response to changes in demand in order to stabilize value. Stablecoins are cryptographically secured, allowing users to settle transactions near-instantaneously without double-spending or requiring an intermediary to facilitate settlements. Stablecoins are also typically built on distributed ledger technology standards (DLTs) that are programmable and composable, allowing them to function as self-contained building blocks that interoperate with smart contracts on the blockchain to create payment and other financial services.
Given the early stages of this technology, frequently developers can be seen releasing their own unique approach towards a stablecoin design, however, we can generally bucket stablecoins into three different categories: public reserve-backed (custodial stablecoins), public algorithmic, and institutional/private (tokenized deposits).
Stablecoins with public reserves are the most common of the three and are backed by cash-equivalent reserves (bank deposits, treasury bills, commercial paper), issued by centralized firms and circulate on public blockchains, such as Ethereum, Polygon, or Binance Smart Chain. Circle’s USD coin is a popular example of this.
Public algorithmic stablecoins are backed by overcollateralized cryptocurrency and/or smart contracts that automatically defend the peg by buying or selling the stablecoin. These stablecoins are controlled by the possession of a governance token, a specialized token primarily used for voting on changes to protocol or governance parameters. These types of coins are typically labeled algorithmic due to either its collateralized mechanism or its algorithmic peg mechanism.
Institutional/private stablecoins are issued by financial and non-financial institutions for internal account transactions, liquidity management, and transactions between user accounts within the same private network. They are used by traditional financial institutions and their clients for efficient wholesale transactions.
Stablecoins are primarily used for their near-instant, 24/7, non-intermediated payments with typically low fees. Presently, their most common areas of use are within decentralized finance (DeFi), digital markets, payments, and internal transfers for liquidity management. Within DeFi, stablecoins’ protocols allow for market making, collateralized lending, derivatives, asset management, and other services. In digital markets stablecoins are used as an onramp from fiat currency to digital assets and are used to trade these digital assets on the blockchain. For payments, stablecoins help facilitate fast peer-to-peer and cross-border payments. Institutional stablecoins facilitate internal transfers of funds within a firm and allow efficient movement of internal cash across subsidiaries to manage liquidity risk and regulatory requirements.
As stablecoin development continues, more use cases related to consumer payments have begun to emerge. While these use cases are still in their early stages the areas they address can broadly be broken down into two different categories: financial market innovation and transaction facilitation innovation.
With stablecoins we have the ability to innovate financial markets in a way that creates more inclusive payment and financial systems. As mentioned earlier in this note, stablecoins can be used to transfer funds near instantaneously peer-to-peer between digital wallets for typically low fees. By taking advantage of this feature, we would see lower payment barriers and pressure would be exerted on existing payment systems to provide better services. This is especially important for cross-border transfers, which typically take several days to clear and carry high fees. Due to these challenges, low and middle-income countries typically choose to receive financial support from the less efficient method of remittances.
Tokenized financial markets have also seen enabled growth due to stablecoins. Tokenization entails converting securities into digital tokens on DLTs and trading/servicing them with stablecoins. Financial markets would benefit from the programmability of DLTs, which could automate security servicing and regulatory requirements, such as required holding periods. The benefits gained within the tokenized financial markets can be further separated between delivery-versus-payment (DvP) transactions and payment-versus-payment (PvP) transactions.
Within DvP transactions, such as security purchases, stablecoins allow for real-time settlement at much lower costs. Stablecoins also enable increases in liquidity, transaction speeds, and transparency while reducing counterparty risk, trading costs, and other barriers to market participation. This benefits many asset classes, such as real estate, allowing for fractional ownership of tokenized assets and more transparent price discovery.
Stablecoins enable PvP transactions, such as cross-currency swaps, to have near-instantaneous execution instead of the market’s current conventional T+2 framework, in which a swap’s payments are settled two business days after the swap is struck.
Stablecoins enable the facilitation of transactions and microtransactions for next-generation innovations. Early use cases for this have emerged in the categories of web 3.0, credit cards, small and medium sized businesses (SMB), and retailers.
Web 3.0 can be defined as the move away from centralized web platforms and data centers towards decentralized networks. This move has created a shift in revenue focus from advertisements and the sale of user data to consumer micropayments through use of stablecoins. This creates a world/metaverse of layered possibilities and future innovations within the social web and consumer space that have yet to be uncovered.
Credit card companies have already started attempts at taking advantage of stablecoin technology. Some of these use cases entail allowing consumers to make payments with their card linked to a stablecoin. This has shown to be a more reliable option compared to less stable cryptocurrencies such as Bitcoin or Ethereum. Stablecoin integration also enables other features for credit card companies such as the ability to instantly convert a stablecoin into the local currency of the merchant’s bank upon purchase. New approaches to credit limits have emerged as well, such credit cards backed by the cardholder’s stablecoin reserves as opposed to credit score and income.
Stablecoins have shown to provide many benefits for small and medium sized businesses of various industries, such as the gig economy. An open payments system will drive competition, lower transaction fees, and unbundle services related to reversibility and chargebacks, intermediation, and transaction risk assessment. This will empower businesses to pay only for what is necessary without compromising which customers they can accept payments from. SMB within various industries would see lower costs and faster access to funds thus improving their liquidity and cash buffers.
Retailers have also started integrating stablecoin technology to further attract consumers. Stablecoins take away risk associated with payment through other digital currencies. Recent studies have reported that 75% of retailers plan to accept either cryptocurrency or stablecoin payments within the next two years.
While stablecoins are still in their early stages and risks associated with general crypto-as-payment usage continue to present a barrier for growth, clear benefits have already emerged. Given the growth we’ve seen in this space in the past year alone, the scale of potential impact that these newer consumer use cases present is multiples greater than any comparable past event. As stablecoins continue to enable innovations for consumer payments and lower the barrier of adoption to bring new, engaged users in the crypto space, a point of mass adoption should eventually arise.