Stable Coins, Stable Growth

The core function of blockchain networks is to securely process and maintain timestamped information records. In principle, this can be any kind of data, but the most typical example is information related to financial balances and transactions. The simplest, most common financial transaction is payment and, while most blockchains today serve multiple use cases, processing transfers of nominal units of value — such as when paying for goods, services, or other cryptoassets — remains an essential use case for all major networks. But while successful blockchains are already dominant payment networks in some niche markets, their success for everyday payments at scale is much more strongly tied to government-regulated fiat as opposed to cryptocurrencies.

Money and payment networks can be public or private. In this context, ‘public’ refers to the government, the central bank, and other public sector institutions, whereas ‘private’ refers to privately owned and operated entities, such as most commercial banks, credit card companies, and other financial service providers. In practice, the lines between the two are not as clear-cut as in the idealized quadrant below, since public money issued by governments circulates in private networks and much of the private financial sector is heavily regulated by public institutions. However, the public-private distinction is a good starting point for thinking about how emerging forms of money and payment systems relate to the status quo.

There are two ways to interpret and exemplify this table: (1) across all monetary units of account, and (2) within a governmentally defined unit of account, typically tied to a national currency. In the first case, money is arguably truly ‘private’ only if it’s issued by a private sector entity, uses a different numeraire than those defined by national governments, and transacts independently of government-controlled settlement networks. Free-floating cryptocurrencies such as bitcoin and ether are examples of such private sector monies, although their adoption as monetary units of account and payment media has been quite limited outside of some crypto-native markets such as blockchain transaction fees, digital items represented as non-fungible tokens (NFTs), and other blockchain-related goods and services. Due to the very powerful network effects of national currencies, the use of non-crypto private monies for everyday payments has been similarly marginal.

In the second case, money associated with national currencies can also take a more ‘public’ and a more ‘private’ form. This is illustrated by the classic hierarchy of money where acceptability and liquidity decrease from top to bottom: the most universally accepted and liquid forms of (public) money sit at the top of the hierarchy, while the most narrowly accepted and least liquid (private) forms are at the bottom. While there may be regional and historical variations, the image below is broadly reflective of the current situation in most modern economies where the right to issue currency is limited to central banks while the money unit of account associated with that currency is used by commercial banks, non-bank financial intermediaries, and the private sector at large, to denominate credit and securities that, at varying degrees, are treated as cash equivalents.

Whereas the most widely adopted private sector monies, including free-floating cryptocurrencies, may develop their own independent monetary hierarchies (which are interesting for reasons outside the scope of this article), national currencies and their respective hierarchies overwhelmingly dominate the payments use case around the world. This is relevant to blockchains because their success as payment networks at scale seems increasingly less tied to private crypto monies (as defined above) than to a special set of cryptocurrencies that belong to the same monetary hierarchies as government monies. These cryptocurrencies, known as stablecoins, are designed to closely track the market value of some other asset. As of this writing, the most widely used reference asset for stablecoins is the most liquid fiat currency in the world — the US dollar. As such, most stablecoins effectively belong to the monetary hierarchy organized under the Federal Reserve System of the United States.

Payment networks — serving different segments of the retail and institutional customer base and using different mediums of settlement (e.g., central bank reserves, commercial bank deposits, other private sector IOUs) — exist at all levels of this US dollar hierarchy. For example, high-value transactions between banks are handled through Fedwire and the Clearing House Interbank Payments System (CHIPS), whereas lower-value transactions such as paying for utility bills or transferring commercial bank deposits between family and friends are handled by the Automated Clearing House (ACH). The most popular point-of-sale payment method is debit/credit cards, which are typically issued by banks and can be linked to mobile payment apps. The largest networks processing these types of payments are currently operated by publicly traded companies such as American Express, MasterCard, and Visa. Finally, payment gateway and processing providers such as PayPal, Square, and Stripe supply merchants with easy access to the most popular networks, helping abstract away the complexity of the plumbing that connects different parts of this system.

At each level of the monetary hierarchy, control over payment networks includes the power to dictate what can serve as an accepted means of payment at that particular level. That’s why accounting protocols — whether self-imposed or prescribed by financial regulators — are so important. For the most part, ‘issuing money’ becomes easier as one moves down the hierarchy, but it also becomes more difficult to get others to accept it. On one end of the spectrum, physical cash and commercial bank deposits are almost universally accepted as means of payment, but the ability to issue them is tightly regulated; at the other extreme, essentially anyone is free to issue private debt, but such IOUs may perform monetary functions only within a narrowly defined context, such as when using gift cards or loyalty points issued by specific businesses, or when a small group of people maintain a ledger of mutual credits that few outside of their community would accept in lieu of money. In short, not all forms of monetary payment are created equal, and both the type of ‘money’ changing hands and the payment network used to facilitate the transaction depends on the context and counterparties involved.

How do USD-based stablecoins that settle on blockchain networks fit into this picture? When considered across all monetary units of account, they can arguably be placed in quadrant C in the image above. In this view, although issued by the private sector, by being tied to the US dollar, stablecoins are not truly private sector monies in the same way as bitcoin and ether are. This is especially true for stablecoins backed by dollar deposits or cash equivalents (or even physical commodities) custodied by regulated US financial institutions, which places these stablecoins slightly higher up in the hierarchy compared to those backed by offshore assets, even though both ultimately belong to the same broad category somewhere below insured bank deposits. Stablecoins backed entirely by free-floating cryptocurrencies are a special case because they have minimal touchpoints with the existing financial system. However, when explicitly designed to track the value of the US dollar as their reference asset, such stablecoins can still — albeit very loosely — be categorized as belonging to quadrant C.

When viewed through the lens of a governmentally defined unit of account (USD), however, anything but the monetary base of physical currency and reserves held at the central bank is a liability of some private sector entity and can thus be categorized as ‘private’ money. From this perspective, given that all such liabilities — including stablecoins — also circulate in payment networks operated by the private sector, they can arguably be placed in quadrant D. While there are important qualitative differences between stablecoins depending on where the issuer and their primary banking partners are domiciled, the increasingly popular saying that “onchain is the new offshore” highlights the similarities between stablecoins and offshore USD, i.e. ‘Eurodollar’, deposits outside the direct purview of US regulators. But even if the assets backing stablecoins are custodied by US-regulated financial institutions, from the perspective of their holders, they still represent USD liabilities that lack the governmentally guaranteed insurance of commercial bank deposits. While the counterparty and financial risks associated with individual stablecoins may vary, this ultimately puts them in the same category as all other privately issued forms of USD-denominated debt that lack such guarantees but are nonetheless treated as money.

However, there is one feature that makes stablecoins unique: they’re issued on decentralized programmable blockchains. This means that anyone with an Internet-connected device can, without requiring authorization, spin up a self-custodial digital wallet, start receiving fast peer-to-peer payments globally at a very low cost, and gain access to blockchain-based financial services. In other words, the innovative part of stablecoins is not monetary but technological and distributional. By being natively digital, global, and programmable, stablecoins have the potential to become a more powerful and convenient form of digital cash than anything that currently exists. The main obstacles to realizing this potential are best highlighted by considering three alternative adoption scenarios of stablecoins (and thus blockchain networks) for everyday payments:

1. Niche / Marginalization
   In this scenario, stablecoins see their highest rates of adoption in some niche markets (both crypto-native and traditional) and under special circumstances (such as in a currency crisis or in regions with highly underdeveloped or dysfunctional financial services infrastructure) but remain marginal in the context of everyday payments at a globally significant scale. In most developed economies, existing payment methods such as debit/credit cards, non-cryptocurrency mobile wallets, and even physical cash are very convenient and reliable, and the need for alternative means of payment is minimal. Without a strong enough demand pull from consumers, stablecoin payments may thus struggle to break out into the broader economy, especially when combined with unfavorable regulatory treatment in key jurisdictions, discouraging their use as an alternative or add-on to traditional bank deposits.
2. Mainstream / Integration
   In this scenario, blockchain-based and traditional financial services will gradually converge as stablecoins become tightly integrated with the existing payment infrastructure. Pro-crypto regulatory clarity attracts established financial institutions, especially banks, to issue or otherwise support stablecoins, thereby increasing trust in the underlying blockchains. As lines between stablecoin and traditional bank accounts blur, a unified regulatory framework will eventually emerge, solidifying blockchains as a foundational component of global financial infrastructure with an embedded, increasingly automated compliance regime. Major stablecoin issuers will become systemically important financial institutions but, depending on their architecture and regulatory status, their risk profiles will vary. As a result, in the case of a major financial crisis, some of them may run into trouble, thus presenting governments and central banks with challenges similar to those that emerged during the aftermath of the 2007–2008 Global Financial Crisis, further entrenching their role as lenders and market makers of last resort. At the same time, the transparency and programmability of blockchains will increase the stability and resilience of the financial sector, paving the way for future monetary reform within the political and regulatory confines of national currencies, and culminating in central bank digital currencies (CBDCs) managed by governments or through public-private partnerships.
3. Alternative / Disruption
   In this scenario, stablecoins and blockchain-based financial services more broadly grow in parallel to the existing financial system. Over time, instead of becoming tightly integrated with traditional financial institutions and payment infrastructure, blockchains are increasingly viewed as a systemic alternative, directly competing with and eventually replacing the legacy system. While incumbent institutions will adapt by launching their own blockchains or becoming users of regionally dominant public networks, many of them will struggle against their more crypto-native competitors. Given the unique capabilities and risk profile of blockchain-based financial services, most jurisdictions will prefer to develop entirely new regulatory frameworks instead of trying to fold them into existing regulations. While stablecoins tied to national currencies will initially serve as the dominant form of money for most onchain payments, eventually crypto monies that are not tied to existing currencies but capable of maintaining a sufficiently stable exchange value against a broad basket of consumer goods will emerge. In the long run, the most disruptive possible outcome would be for such cryptocurrencies (and thus their underlying blockchains) to become widely adopted in everyday commerce and even international commodity markets, thereby ushering in an entirely new monetary system that will also necessitate the creation of new institutions of global monetary governance. To address the challenges that led to the system that preceded it, this new institutional structure will greatly benefit from having its operational and regulatory logic embedded in the underlying blockchain protocols.

Historically, most cryptocurrencies have exhibited considerable price volatility, making them unfit to be used as monetary units of account and generalized means of payment. Stablecoins solve this problem and have arguably emerged as one of the most successful use cases for blockchains to date. While network- and application-specific tokens have important operator-, developer-, and governor-facing utilities, when it comes to everyday payments, they have significantly higher adoption hurdles than stablecoins tied to offchain currencies that consumers are already familiar with. Regardless of which of the above scenarios is realized, the growth of blockchains as payment networks is therefore tied to the success of stablecoins. And while some may interpret this as contradicting the original ethos behind blockchain-based monetary experiments, by contributing to the institutionalization of the underlying infrastructure, stablecoin adoption will increase the legitimacy of this infrastructure for all other use cases as well.

The author’s work is funded by Placeholder, a venture capital firm that invests in open blockchain networks and Web3 services.

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