By Stuart Dee
The financial world is undergoing a seismic shift. Decentralized finance (DeFi) and centralized finance (CeFi) are challenging the dominance of traditional finance (TradFi), while cryptocurrency continues to grab headlines with its high-risk, high-reward potential. Bitcoin’s price swings, Blackrock’s forays into crypto ETFs, and the allure of staking yields all contribute to the growing appeal of cryptocurrencies, despite their volatility.
In this evolving landscape, stablecoins have emerged as a bridge between the stability of traditional finance and the innovation of cryptocurrences. Unlike other cryptocurrencies whose value can fluctuate wildly, stablecoins are pegged to a stable asset, typically a fiat currency like the US dollar. This peg aims to offer a more predictable store of value within the crypto ecosystem.
However, the question of true stability and governance in the permissionless world of blockchains, where new protocols constantly emerge, remains a concern. The sheer number of stablecoins is itself a testament to the rapid evolution of the space, with established players like Ripple and even PayPal entering the arena.
Collateralised stablecoins, those backed by reserves of fiat currency held by a central entity, are particularly promising for bridging the traditional-crypto gap. However, the lack of regulation that has characterised the crypto market since Tether’s launch in 2014 presents challenges.
Fortunately, regulatory bodies in Europe and the UK are starting to turn their attention to stablecoins. Implementing Know Your Customer (KYC) and Anti-Money Laundering (AML) processes for institutions issuing stablecoins can significantly improve transparency and security. But true stability will hinge on global cooperation. In the BIS research on Global Stable Coins 2109 they state, “This collaboration is essential to prevent regulatory arbitrage – where institutions exploit loopholes in different jurisdictions – and ensure a level playing field that protects consumer data, operational resilience, and tax compliance”.
Research suggests there may be inherent limitations to stablecoin stability. Studies by Grobys et al. (2021), Hoang and Naur (2022), and Kun Duan and Andrew Urquhart (2023) all highlight potential issues with volatility, excess price variations, and co-movements that can undermine stability. Even Tether, the largest stablecoin, is not immune. In 2022, it briefly lost its peg to the US dollar, raising concerns. Standard & Poor’s further stoked these concerns in December 2023 by questioning Tether’s ability to maintain the peg due to a lack of transparency on its reserves.
So, if stablecoins appear to have these drawbacks, what’s driving their adoption? Research by Hoang and Baur (2022) suggests that the answer lies in their utility. Despite potential stability issues, stablecoins offer significant advantages over traditional fiat currencies, particularly in terms of lower transaction costs.
The UK funds industry, known for its conservative approach to new financial instruments, reflects a cautious optimism towards crypto. The Investment Association UK Fund Tokenisation Report (November 2023) predicts a global market size of $4-5 trillion, focusing on mainstream asset classes like equities and bonds. This growth underscores the potential of tokenisation, but also highlights the need for a robust regulatory framework.
Looking beyond stablecoins, central banks are laying the groundwork for their own Central Bank Digital Currencies (CBDCs). Unlike stablecoins, which bridge the gap between traditional and crypto finance, CBDCs could offer a complete integration, offering a government-backed digital currency that could unite both financial worlds.
In conclusion, stablecoins represent a significant innovation in a rapidly evolving financial landscape. While questions remain about their true stability and governance, they offer a valuable bridge between traditional and crypto finance. As the regulatory landscape matures and central banks explore CBDCs, the future of stablecoins, and cryptocurrencies as a whole, promises to be fascinating to watch.