Stablecoins need even more trust

• Justin Thomson
  Head of Investment Institute
  T. Rowe Price

But as always with technological innovations, there are reservations. One is that a digital currency backed by fiat money is still fiat money – and fiat money is based on trust, both in government policy and in the credibility of the issuing central bank with regard to inflation. A useful reference point here is the eNaira, Nigeria’s publicly issued stablecoin, which has been largely shunned by consumers, who have instead opted for privately issued, dollar-backed stablecoins. One of the reasons for the slow uptake of the eNaira (less than 0.5% of Nigerians used it within a year of its launch) is that it is merely a digital version of the underlying fiat currency (the naira), which has seen its trust erode significantly in recent years.

An alternative way to ensure stability is to back a digital currency with a real asset such as gold or silver – or even cheese (the Italian bank Credito Emiliano is known for backing its currency with wheels of Parmigiano Reggiano). There are algorithmic methods that use supply and demand formulas to keep the value close to the reference value. However, these are generally less proven and involve a higher risk. It is also important to note that the consumer protection measures of the aforementioned GENIUS Act lag significantly behind those for other financial products. If stablecoins are successful, they will impact the business of banks, while being far less strictly regulated.

There is also disagreement about the potential “anarchy” caused by the issuance of currencies by multiple private actors. From a blockchain/crypto technology perspective, we have finally achieved interoperability with ease of use. However, given the imminent proliferation of stablecoins by new issuers, there is a practical question as to whether multiple competing issuers with their own platforms and on/off ramps could create competing “walled gardens” that would negate the efficiency benefits of stablecoins for payments.

There are both negative and positive precedents here. The era of “free banking” in the mid-19th century, ushered in by President Andrew Jackson’s successful campaign against a federal central bank, led to chaotic monetary conditions as each bank issued its own currency, which traded at different exchange rates. However, the issuance of banknotes by commercial banks in Scotland and Hong Kong remains an accepted and orderly norm.

A question of trust

Ultimately, much depends on the question of trust. The Bank for International Settlements, the umbrella organisation for central banks, has warned that the uncontrolled rise of stablecoins could undermine public confidence in money. For users to trust that the value of a stablecoin will remain unchanged, they need to know that its collateral is verifiable, liquid and high-quality. And although adequately backed stablecoins offer some advantages over “trad-fi” currencies (particularly in terms of transaction speed and costs), such tied assets are always exposed to the risk of runs by holders seeking to convert their holdings back into dollars or another currency. The two most important stablecoins – Tether and USDC – have briefly fallen below their value of 1 USD. These risks are not new in the modern financial world. Money market funds broke the buck during periods of severe market stress, such as in 2008.

An alternative vision for the new state of money is digital central bank currencies, which are issued and regulated directly by the central bank and are comparable to a publicly issued stablecoin. Both the eurozone and China are pursuing this path. If one of these options prevails, the dominance of the US dollar as the global reserve currency could be called into question once and for all. There are currently around 250 billion US dollars worth of stablecoins in circulation worldwide, almost all of which are pegged to the dollar. The successful introduction of a digital euro will be an important litmus test: if the European Central Bank gets it right, it will show that an option for the public sector outside the US dollar is feasible.

In my opinion, there is currently a lot of FOMO (fear of missing out) when it comes to stablecoins. As my colleague Blue Macellari, our in-house crypto specialist, jokingly says: “Who wouldn’t want to launch a stablecoin? I would if I could!” Since stablecoins simplify trading in cryptocurrencies, their lasting advantage could lie in connecting investors with other parts of the cryptosphere.

Whether stablecoins will become the dominant or even a significant means of payment outside the world of digital assets is questionable: there is now a clear path to a modern payment landscape that enables instant, low-cost and secure transactions, including 24-hour trading and financial inclusion, as stablecoins give people without bank accounts access to digital money. The technology is there, and the regulatory framework is taking shape – but it may take a little longer to build the trust needed to finally bring stablecoins into the mainstream.