It is no news that crypto is making its way into mainstream finance, becoming increasingly popular and widely adopted. Unsurprisingly, traditional finance players are showing resistance to such a revolutionary asset type.
In recent weeks, there has been plenty of media attention as regulators in the US seek to increase scrutiny over stablecoins. They have become something of a sensation, with growth ballooning 500% in the last year, reaching a market cap of $127 billion, according to Reuters. New research has shown that stablecoins were used in $1.77tn of transactions in the second quarter of 2021.
What are stablecoins?
Stablecoins were designed to address the extreme volatility and fluctuation of the cryptomarket. To do this, stablecoin issuers peg the value of their coins against an asset or fiat currency, most commonly the US dollar. Unlike other cryptocurrencies, stablecoins are more centralised as they are linked to an entity that ensures off-chain collateral stability.
The most famous stablecoins are those used for trading on crypto exchanges, such as Binance USD, Coinbase’s USD coin and Bitfinex’s Tether, which usually rank among the top five highest market caps for cryptocurrencies.
As stablecoins tend to be less volatile, they can provide new investors with a sense of security and safer exposure to the crypto market.
In broader terms, stablecoins can be seen as the first step into the crypto universe, as they are used to facilitate crypto trade: Instead of buying Ethereum directly with fiat currency, most users will exchange fiat for a stablecoin in an exchange, then proceed to buy other coins with it.
While the main function of stablecoins is to serve as intermediary currency between fiat and crypto, that is not its only capacity. Stablecoins can also be used for lending and remittances, which adds a lot of user value, especially in developing countries with high rates of inflation and financial instability.
Crypto adopters in Latin America have embraced stablecoins as a way to hold value in dollars without being exposed to currency depreciation, said Bitso CEO Daniel Vogel to Coindesk. According to Vogel, pandemic-related uncertainty has spurred this trend and increased the number of stablecoin users in the region.
Stablecoins vs CBDC?
Central bank digital currencies (CBDC) are another type of digital coin attracting recent attention. The Bank of England (BoE) announced in November that it is already studying and exploring opportunities for a centralised digital currency. During the next year, BoE will consult with industry experts and analysts about the benefits and risks of a UK-based CBDC.
While stablecoins and CBDC may sound similar, there are important differences, especially with regards to their governance. Firstly, a CBDC has a strong institutional nature. It is a fully regulated and centralised currency, very much like the traditional fiat currencies, but in a digital form built on blockchain technology. The central bank will still retain full monopoly over the monetary system, and control aspects related to issuing, exchange and governance.
This means that CBDCs are a lot less revolutionary than the truly decentralised cryptocurrencies; they are a way for authorities to extend their control over finance in the digital world.
Stablecoins, on the other hand, are somewhat centralised but are neither regulated (as of yet) nor controlled by financial institutions. In most cases, stablecoin governance is determined by the crypto exchange, used mostly to facilitate trading for users.
Watch our latest #FinancialFox episode "Regulating the new finance: Stablecoins, CBDCs and digital assets" with Charles Dhaussy, Managing Director Asia-Pacific region at ConseSys. A discussion about the role of stablecoins, CBDCs and if regulation can be beneficial or damaging for crypto.
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