Placeholder: Thinking about the growth potential of stablecoins from the perspective of currency level

Original author: Mario Laul

Original translation: Luffy, Foresight News

The core function of a blockchain network is to securely process and maintain a time-stamped record of information. In principle, blockchains can record any type of data, but most typically information related to financial balances and transactions. The simplest and most common financial transaction is a payment, and while blockchains currently serve a variety of use cases, processing the transfer of units of value (e.g., paying for goods or services) remains the fundamental use case for all major networks. However, while successful blockchains have become the dominant payment networks for some niche markets, their success in everyday large-scale payments has generally come from stablecoins pegged to fiat currencies.

Money and payment networks can be either public or private. Public refers to governments, central banks, and other public sector institutions, while private refers to privately owned and operated entities, such as most commercial banks, credit card companies, and other financial service providers. In practice, the line between the two is not as clear as it is in the quadrants in the figure below, because public currencies issued by governments circulate 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 the relationship of emerging money and payment systems to existing systems.

This table is explained and illustrated below for two cases: (1) covering all monetary units of account, and (2) within government-defined units of account, usually pegged to a national currency.

In the first case, a currency can only be truly “private” if it is issued by a private sector entity, uses a different unit of account than the one defined by the government, and is traded independently of a government-controlled settlement network. Free-floating cryptocurrencies such as Bitcoin and Ethereum are examples of such private currencies, although their use cases as units of account and payment media are quite limited, such as blockchain transaction fees, NFTs, and other blockchain-related goods and services. Because national currencies have very strong network effects, private currencies other than cryptocurrencies also have few use cases in everyday payments.

In the second case, the currency associated with the national currency can also take a more public or more private form. This can be illustrated by the classic hierarchy of currencies, where acceptance and liquidity decrease from top to bottom: the most accepted and liquid (public) currencies are at the top of the hierarchy, while the worst (private) currencies are at the bottom. While there may be regional and historical differences, the figure below roughly reflects the situation in most modern economies, where the right to issue currency is limited to the central bank. The monetary unit associated with the currency is used by commercial banks, non-bank financial intermediaries, and the private sector to denominate credits and securities, which are treated as cash equivalents to varying degrees.

While the most widely adopted private currencies (including free-floating cryptocurrencies) may develop their own independent currency hierarchies, national currencies and their hierarchies dominate payment use cases around the world. This is relevant to blockchains because their success as large-scale payment networks seems to be less and less tied to private cryptocurrencies, but rather a special group of cryptocurrencies in the same currency hierarchy as government currencies. These cryptocurrencies are called stablecoins and are designed to track the market value of other assets. As of this writing, the most widely used anchor asset for stablecoins is the worlds most liquid fiat currency, the US dollar. Therefore, most stablecoins actually belong to the currency hierarchy under the US Federal Reserve System.

Payment networks serve different retail and institutional customer segments and use different settlement media (e.g., private IOUs, commercial bank deposits, central bank reserves), and exist at all levels of the dollar hierarchy. For example, large transactions between banks are processed through Fedwire and the Clearing House Interbank Payments System (CHIPS), while smaller transactions such as paying utility bills or transferring commercial bank deposits between family and friends are processed by the Automated Clearing House (ACH). The most popular sales-side payment method is a debit/credit card, which is typically issued by a bank and can be linked to a mobile payment app. Currently, the largest networks processing such payments are operated by public companies such as American Express, Mastercard, and Visa. Finally, payment gateways such as PayPal, Square, and Stripe provide merchants with easy access to the network, helping to abstract the complexity of the channels connecting the different parts of the system.

At every level of the monetary hierarchy, control over payment networks includes the power to decide what counts as an acceptable means of payment. This is why accounting protocols are so important. In most cases, as you go down the hierarchy, it becomes easier to “issue money,” but it becomes increasingly difficult to get others to accept it. On the one hand, physical cash and commercial bank deposits are almost universally accepted as means of payment, but the ability to issue these currencies is strictly regulated. On the other hand, essentially anyone is free to issue private debt, but such IOUs can only function as money in a very narrow range, such as using gift cards or loyalty points issued by specific businesses. In short, not all forms of monetary payment are created equal.

How do USD stablecoins settled on blockchain networks fit into this system? From a monetary unit perspective, USD stablecoins can be said to be in the C quadrant of the above diagram. Although stablecoins are issued by the private sector, they are not truly private currencies like Bitcoin and Ethereum due to their peg to the US dollar. This is especially true for stablecoins backed by US dollar deposits or cash equivalents (or even physical commodities) held in custody by regulated US financial institutions, which puts these stablecoins slightly higher in the hierarchy compared to stablecoins backed by offshore assets, although both ultimately belong to the same general category, below insured bank deposits. Stablecoins backed entirely by free-floating cryptocurrencies are a special case because of their low correlation with the existing financial system. However, when explicitly designed to anchor the value of the US dollar, these stablecoins can still be classified in the C quadrant.

From the perspective of the government-defined unit of account (the dollar), anything other than physical currency and reserve currency held by central banks is a liability of private sector entities and can therefore be classified 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 be said to be in Quadrant D. While there are important qualitative differences between stablecoins, depending on the location of the issuer and its primary banking partners, the increasingly popular saying that “on-chain is the new offshore” highlights the similarities between stablecoins and offshore dollars (i.e., “Eurodollars”), which are deposits that are not directly regulated by U.S. regulators. But even if the assets backing stablecoins are held in custody by U.S.-regulated financial institutions, from the perspective of the holder, they still represent U.S. dollar liabilities that lack government-guaranteed commercial bank deposit insurance. While the counterparty and financial risks associated with specific stablecoins may vary, this ultimately puts them in the same category as all other privately issued forms of U.S. dollar-denominated debt that lack collateral but are still considered money.

However, stablecoins have one unique feature: they are issued on a decentralized, programmable blockchain. This means that anyone with an internet-connected device can register a self-hosted digital wallet without permission, receive peer-to-peer transfers around the world at a very low cost, and access blockchain-based financial services. In other words, the innovative part of stablecoins is not the currency, but the technology and distribution. Being natively digital, global, and programmable, stablecoins have the potential to become a more powerful and convenient form of digital cash than any current currency. What are the main obstacles to realizing this potential? Here are three possible adoption scenarios for stablecoins in everyday payments:

Niche/Marginal

Stablecoins have the highest adoption rates in certain niche markets (both crypto-native and traditional) and in special circumstances (e.g. currency crises or regions with highly underdeveloped or dysfunctional financial services infrastructure), but remain marginal in everyday payments around the world. 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 there is little demand for alternative payment methods. Without sufficiently strong consumer demand, stablecoin payments may have difficulty entering the wider economy. In particular, if stablecoins encounter unfavorable regulatory treatment in major jurisdictions, their use as a substitute or supplement to traditional bank deposits will be hindered.

Mainstreaming/Integration

As stablecoins become more integrated with existing payment infrastructure, blockchain-based and traditional financial services will gradually merge. The regulatory clarity supporting cryptocurrencies has attracted established financial institutions, especially banks, to issue or otherwise support stablecoins, thereby increasing trust in the underlying blockchain. As the lines between stablecoins and traditional bank accounts blur, a unified regulatory framework will eventually emerge, cementing blockchain’s position as a foundational component of global financial infrastructure through embedded, increasingly automated compliance regimes. Major stablecoin issuers will become important financial institutions, but with different risk profiles depending on their architecture and regulatory status. As a result, in the event of a major financial crisis, some of these institutions may be in trouble, thus posing challenges to governments and central banks similar to those that emerged after the 2007-2008 global financial crisis, further consolidating their roles as lenders of last resort and market makers. At the same time, the transparency and programmability of blockchain will increase the stability and resilience of the financial sector, paving the way for future monetary reforms in countries and ultimately forming central bank digital currencies (CBDCs) managed by governments or through public-private partnerships.

Replacement/Subversion

Stablecoins and blockchain-based financial services will develop in parallel with the existing financial system. Over time, blockchain will no longer be closely integrated with traditional financial institutions and payment infrastructure, but will increasingly be seen as a systemic alternative that will directly compete with and eventually replace the traditional system. While existing institutions will adapt by launching their own blockchains, many of these institutions will compete with more native cryptocurrency counterparts. Given the unique features and risk profile of blockchain-based financial services, most jurisdictions will prefer to develop entirely new regulatory frameworks rather than try to fit them into existing regulations. While stablecoins pegged to national currencies will become the dominant form of currency for most on-chain payments, cryptocurrencies that are not pegged to existing currencies but are able to maintain sufficiently stable exchange rates with a basket of consumer goods will eventually emerge. In the long run, the most disruptive outcome would be the widespread adoption of these cryptocurrencies in everyday commerce and even international trade, thereby establishing an entirely new monetary system, which will also require a new global monetary governance institution.

Historically, most cryptocurrencies have exhibited considerable price volatility, making them unsuitable for use as a monetary unit of account and general means of payment. Stablecoins solve this problem and are arguably one of the most successful use cases for blockchain to date. While tokens for specific networks and applications have important utility for operators, developers, and managers, their adoption barriers for everyday payments are significantly higher than stablecoins pegged to off-chain currencies that consumers are already familiar with. Therefore, no matter which of the above scenarios occurs, the growth of blockchain as a payment network is closely tied to the success of stablecoins.

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