Digital Currency: Understanding Risks, Opportunities of Stablecoins

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Stablecoins, a type of digital currency, have broad potential within banking and finance, and for the overall economy, as a way to process payments, develop new products and bridge the gap between physical and digital currency.

They also entail new risks that could undermine financial stability and monetary sovereignty if adopted at a significant scale without a strong regulatory and oversight framework. In this report, we answer frequently asked questions about the risks and opportunities related to the growth of stablecoins.

What are stablecoins, and how do they differ from cryptocurrencies and central bank digital currencies (CBDCs)? For a currency to be viable, it must offer enough confidence in its ability to act as a medium of exchange to effectively enable transactions.

Unlike cryptocurrencies, which are highly volatile, stablecoins are an attempt to create private digital currencies tethered to a fiat currency or a stable asset that is less volatile, while allowing for the convenience of cryptocurrency by means of instant consensus-based settlement and privacy.

Therefore, a stablecoin can be defined as a value-stable digital currency whose market price is backed by a low-volatility based stable asset. Stablecoins also differ from central bank digital currencies (CBDCs), which are digital representations of legal tender and direct liabilities of the central bank itself.

In contrast to CBDCs, stablecoins are a private-market digital alternative to fiat currency in terms of a reliable medium of exchange. Stablecoin transactions occur without a bank intermediary, enabling instantaneous settlement between transaction parties, regardless of geographic location.

Stablecoins

They have the potential to bring about more competitive economic markets by offering improved efficiency and broader financial inclusion under a regulatory framework and provide new benefits and lower costs to cross-border payment transactions given their ease of use for international money transfers.

The best known stablecoin initiative is Facebook’s proposed blockchain payment system Diem (previously known as Libra), which the company plans to launch later this year.

Though a number of stablecoins are currently in circulation, Facebook’s vast social media network will provide the payment system for cross-border transactions with a significant and large global user base.

Financial institutions are attempting to find ways to integrate stablecoins into their businesses. Adoption of stablecoins by incumbent financial institutions or technology companies could broaden use of stablecoins in the economy.

Do stablecoins have the potential to disintermediate banks and financial services companies? If widespread adoption of stablecoins occurs, the development of alternative payment networks using stablecoins could pose disintermediation risks to payment providers and money transfer agents.

Competition from stablecoins could also create new risks for commercial banks that issue credit cards and provide cashless payment services to merchants.

These risks include the loss of interaction with their customers and the potential for lower fees that banks and payment providers receive for processing debit and credit card payments.

In assessing the role of stablecoins, bank regulators will likely balance the need to make room for societal benefits from technological advances and innovation, including the efficiencies such advances will bring, on the one hand, and safeguarding the stability of the financial system on the other.

In January 2021, under the Trump administration, one of the three major US bank regulators took action that could allow stablecoins to gain traction among US consumers.

The Office of the Comptroller of the Currency (OCC) indicated that US banks can use stablecoins and independent node verification networks (INVNs) to facilitate payments on behalf of customers.

This flexibility could lay the groundwork for stablecoins to become an alternative payment system, alongside global payment networks such as SWIFT and ACH.

The OCC guidance did stipulate that banks should make sure stablecoin activities are consistent with all applicable laws, including anti-money laundering laws.

However, the OCC under the Biden administration has indicated it intends to review this guidance.

In announcing the review, the recently appointed Acting Comptroller of the Currency expressed concerns that the OCC guidance was not made in full coordination with all stakeholders and that it needs to be viewed as part of a broader strategy to help coordinate regulatory actions governing stablecoins: Markets Forces Africa


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