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One of the "killer apps" of blockchains is the emergence of stablecoins, which are often referred to as cryptodollars. Among these, two of the biggest stablecoins are USDC (issued by Circle) and USDT (issued by Tether). In this article, we’ll go over how cryptodollars are used in emerging markets economies and the impact of parallel USD market on stablecoin adoption.
When the Federal Reserve began raising interest rates, the supply of USDC dropped significantly, while the supply of USDT did not fall as much. This difference suggests that USDC operates more like an on-shore crypto dollar, whereas USDT functions more like an off-shore crypto dollar. USDT holders lack meaningful ways to access the short-term Treasury bond yield, also known as the "risk-free rate."
Despite the inability to access the risk-free rate, many still hold USDT. The primary reason is currency hedging. In off-shore jurisdictions, such as emerging markets, weak governance creates a need for currency hedging. Holding USDT allows individuals in these markets to hedge against currency risks and reduce financial risks within their economies. “High Crypto Penetration Correlates with Weak Governance” [https://niccarter.info/wp-content/uploads/cryptodollars_columbia_nc_mar24.pdf, page 17]
These key insights into the adoption is being well researched and documented. However there exists limited research in the consideration of on-ramping and off-ramping into cryptodollars.
Foreign exchange (FX) distortions occur when there's a significant gap between a government's official exchange rate and the open market rate. These distortions arise from government interventions, market inefficiencies, or economic policies that create artificial discrepancies. Key factors contributing to FX distortions include:
Exchange Rate Controls: Governments impose strict regulations on buying and selling foreign currency, resulting in an official rate that doesn't reflect true market dynamics. This misalignment can lead to significant discrepancies.
Currency Pegs: In a fixed or pegged exchange rate system, a currency tied to another (e.g., the US dollar) can become overvalued if the peg doesn't match economic fundamentals.
High Inflation: Rapid inflation erodes a currency's value. If the official exchange rate doesn't adjust, it becomes overvalued compared to the market rate.
Capital Controls: Restrictions on capital flows can lead to an insufficient supply of foreign currency at the official rate, creating black markets where currency trades at different rates.
Economic Instability: Political and economic instability reduces confidence in the local currency, increasing demand for foreign currencies and leading to parallel markets with more realistic rates.
These factors create parallel markets, or black markets, where foreign currency is traded at rates reflecting true economic conditions rather than artificially maintained official rates. Traders exploit the differences between these rates, further fueling parallel market growth and exacerbating distortions. In summary, FX distortions and the resulting parallel markets highlight the inefficiencies and challenges of maintaining artificial exchange rates.
An example of this is at a store in Trinidad and Tobago, they advertised that they will purchase USDT at 7.5 and if you would like to acquire USDT you can buy at 8.5. Currently the central bank rate is 6.8 TTD for 1 USD
FX distortions make access to USD distorted, leading to the creation of P2P markets, also called "parallel markets." However, spending cryptodollars in emerging markets, where items are not listed in USD, can be challenging. The perception in the first world is that you can easily purchase items with USD, but in practice, this is not always the case. This is evident in dollarized economies like Argentina and Venezuela, where the local currency is so devalued that settling in local fiat is almost a meme. However, this is not true for most emerging market economies.
Despite the challenges, practical solutions exist for spending stablecoins. One approach is using a Visa stablecoin debit card. This allows individuals to save in USD and spend via an off-ramp per purchase. Essentially, you save in a stable currency and spend through a credit card, thus having the best of both worlds.
Purchasing power is a critical element that is often overlooked in advanced economies. It's essential to understand that goods and services are priced in local currencies. In this example, we compare buying a cup of coffee at the Central Bank rate vs. P2P rate:
Given that $1 USD is worth $7 Trinidad and Tobago Dollars (TTD). If a coffee costs $7 TTD, using a credit card to purchase it would effectively cost $1 USD. However, in emerging markets with FX distortions, a parallel market/P2P market exists that changes this price.
In the P2P market, someone like Bob might pay $8 TTD for $1 USD. This would mean that the same 7 TTD coffee could be purchased for $0.875 USD, effectively saving you 12.5%. While this may seem complicated. This simple example lay the foundations for services such as Binance P2P and OKX P2P. Users off off-ramp periodically to obtain this expansion of purchasing power.
The Trinidad and Tobago jurisdiction provides a real-world context of expanded purchasing power. While the Trinidad and Tobago jurisdiction may be more exaggerated, many other jurisdictional P2P markets offer a 0.5-15% discount, translating to an expansion of purchasing power. Over a year of transactions and/or single massive transactions, these savings can add up significantly. People who hold USDT can enjoy a discount on living expenses, including food, rent, cars, and house purchases. P2P markets effectively allow for purchasing power expansion in a given national jurisdiction.
Why not just go to the local banks and access the Central Bank Rate (CBR) if it is better than the P2P price? As mentioned earlier, mechanisms within local banks exist that exclude individuals from participating in the central bank rate, such as:
Quotas on volume
Banking relationships
Documentation requirements for USD purchases
Exhaustive source of funds verification
Extended settlement timeframes
This is not an exhaustive list, and other mechanisms exist. The combination and severity of these factors inherently increase the P2P price. Effectively, there exists a subgroup of people who can access the CBR, while those who cannot must resort to the P2P market.
The smaller the subgroup of individuals who can access the CBR (financial inclusion index), the higher the P2P rate increases. People who cannot access the CBR must pay a premium in the P2P market. These individuals, often time-constrained and in need of immediate USD capital, are willing to pay a premium for the Time Value of Money (TVM). This demand side of the equation increases the purchasing power of P2P bids.
In summary, P2P markets provide significant insights and advantages for those needing currency hedges and immediate financial inclusion. By leveraging these markets, individuals can effectively expand their purchasing power and navigate the complexities of global financial systems.
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