An overview of stablecoins in 2024 - Olaf Ransome

04 March, 2024

Stablecoins; what difference will they make?  

March 04, 2024 - Welcome. This is the first edition of a monthly column on things liquidity. I am going to focus on the plumbing part of liquidity; how to make sure we have enough money and securities in the right currency, in the right place and at the right time to settle trades and make payments. Please do share your views and do ask questions. I’ll try to offer you some help either directly or in a future post. My coordinates are at the bottom.

We’re going to kick-off with something new: Stablecoins. To offer some views on what you can do with them, we need a game of two halves. We'll start by defining what they are, how they work, and the potential risks associated with them. This will help you make informed decisions about using stablecoins. Not an exhaustive treatise, just some basics.

The second half will offer some ideas on how we might see these things being used. Again, not exhaustive, but I hope enough to get you thinking.

The basic building block of a stablecoin is that it is pegged to something and has its value at that peg. So we might consider Tether and its Stablecoin USDT, launched in 2014, as the granddaddy. USDT is pegged to the US dollar. The formal term for this is fiat backed. USDT is by far the most actively used Stablecoin, with a market cap of approaching $100 billion USD. USD Coin (USDC) is the Stablecoin with the second largest market cap, but it is not even close, coming in at $28.5 billion at the time of writing, less than a third the size of USDT. (Please see a table here.)

Stablecoins can also be commodity, crypto or even algo backed. Things algo are a very special case and too complex for this post. If the mood takes, read “Anatomy of a Run: The Terra Luna Crash”.

Defining ‘stable’

Crypto next. Stable and crypto in the same sentence seems like a massive contradiction in terms. If you buy something linked to say the price of Bitcoin, that is not a Stablecoin, its more likely to be an ETF. Only if what you buy has some derivative structure in it which means you can redeem your holding of that structure at a fixed price, do you have something Stable.

This means that the product has to be made of at least two parts, which are perfectly negatively correlated, so if part 1 goes up 10%, part 2 goes down 10%. We call this “Delta 1.0” in finance.

A commodity backed Stablecoin can have one of two main flavours: if the coin is backed only by the commodity, say gold, then it is not a Stablecoin, it is an instrument linked to the commodity price. Again, if what you want is to be able to sell at pre-determined and fixed price, then the Stablecoin needs a derivative structure. I’ll offer the view that none of these three flavours of Stablecoin are for everyday Treasury folk.

For my money (sic) fiat backed Stablecoins are the things which should interest Treasury folks. USDT and later USDC, from Circle, have been widely adopted in the crypto world.

Why? They got a start by filling one very important need for those trading crypto, i.e. Bitcoin, Ethereum et al. Those actively trading these new shiny things did want to sell, but they wanted the optionality of jumping right back in when the price was right.

Herein lies the challenge. Crypto markets work way faster than traditional markets and payments infrastructure. If you sold versus good old fiat cash, then the market is going to move away from you long before you can get fiat back into the system. Think of this like playing ice hockey. You want a rest, but if you take your skates off, then you are not getting back on quickly. Same still holds true in crypto. So, the crypto crowd were willing to hold USDT or USDC; even if those instruments had some risks, they could get back in the game or back on the ice asap.

Stablecoins from a Treasury perspective

Beyond speculation, stablecoins offer various use cases. For example, treasuries can leverage them for efficient cross-border payments or managing short-term cash holdings.

If you are thinking about Stablecoins from a Treasury perspective, the first step is to understand what is being promised. With fiat money, be it commercial bank deposits or reserves at a central bank, the promise is of “redemption-at-par” aka “100 cents on the dollar”.

USDT does not promise that, but USDC does, as does a regulated issuer of e-money such as Monerium with its EURe, or soon to be launched DWS backed AllUnity. And, so too does a regulated payments system such as Fnality. 

Ensuring redemption-at-par

Step #2 is to understand how that redemption-at-par is ensured. In the case of USDC, they are running a Treasury, holding some cash with commercial banks, and making investments in short-term debt instruments. That is a collective investment vehicle or mutual fund. In a stress scenario, they might have to do a fire sale of non-cash assets. In later 2022, USDC traded at below 0.90, “breaking the buck” as it were.

Not a huge risk, and not a big deal if you don’t hold huge amounts of USDC. E-money is generally considered safer as the underlying fiat is usually held in cash, with a margin from the issuer’s capital of some 3% and can be kept with a central bank, offering an additional layer of regulatory oversight compared to some types of stablecoins. Fnality as a payments system has an account for GBP with the Bank of England. Balances in its accounts have a claim on the GBP at the Bank. And those assets are bankruptcy remote from the operating company. That is as low risk as it gets. Tether has been anything but transparent about what it does with the funds it holds. 

Are stablecoins just a holding place?

Now to practical matters. What good is a Stablecoin beyond being a holding place until you get back on the ice rink that is crypto trading?

Crypto or more generally digital assets are “on-chain”. If I try to mix the worlds of “on chain” assets and fiat cash, which is normally “off chain”, then “something’s gotta give”. If you are selling me Bitcoin, you want me to pay first before you deliver me the coin. I want you to deliver first before I pay you. One of us is taking risk; we call this settlement risk. And if you make me keep both my crypto and my cash at your exchange, I have counterparty risk. That’s what FTX’s customers had in spades when it collapsed.

Delivery vs payment (DvP)

If you have been around capital markets or wholesale banking for any length of time, you are probably familiar with the term Delivery vs. Payment (DvP), or PvP the equivalent for FX settlement.  DvP and PvP are atomic settlements; either both things happen simultaneously, or nothing happens - no settlement risk. So, it should not be a surprise that we want the same in matters crypto, aka digital assets, aka, blockchain. Yes, these terms are used loosely. It doesn’t really matter.

Traditionally, ensuring efficient settlement and managing liquidity have been core challenges in financial markets. Blockchain technology offers potential solutions by enabling faster and more secure settlements, potentially improving overall liquidity. In the world of wholesale banking, beyond settling things, ideally DvP or PvP or DvD (delivery vs. delivery) if we are exchanging securities collateral, the other thing we do is make payments. I’m including in that both receiving funds and making payments, aka things P.

If you are close to things Treasury, you’ll already know that liquidity is fragmented; we have money in too many buckets and managing those buckets is hard. Nirvana would be that in any one currency you had one bucket of cash that could do anything you need, be it things P, DvP or PvP.

Just imagine how easy life would be if, in your domestic market, you had the means to do a collateral upgrade on a DvD basis, no settlement risk, then enter into a repo with that better collateral with say your central or national bank to obtain your fiat currency with instant settlement, then swap your local, fiat currency with instant atomic trading and settlement for another currency to settle trades and make payments in that currency. You have been able to exchange what you have for what you need. No settlement risk and no need to use intra-day credit from a Nostro or correspondent bank.

The Concept of ‘SPooL’

I call that one bucket of cash a “SPooL, (Single Pool of Liquidity)” aiming to simplify financial operations by consolidating various functions into a single pool. (For a deep dive, you can download a paper I wrote on this). What actually matters is not whether the SPooL is a Stablecoin, but rather whether the technology can interoperate with all the other parts of the market infrastructure, be those marketplaces, asset custody or means of payment in other currencies. In other words its function not its form. Interoperability is a big word and a big topic. More another day.

While stablecoins offer potential benefits, it's important to note that central banks are also exploring Central Bank Digital Currencies (CBDCs).  Our central bankers are looking at two flavours: retail and wholesale aka wCBDC. In any one currency, a CBDC could be the SPooL. How useful any one wCBDC can be will depend on who is allowed to hold it. The general term for this is “access rules”. That too is a rabbit hole to dive down another day. 

If you are a corporate, then there are number of reasons you might want to be able to handle a Stablecoin. You might want to accept it as means of payment in your e-commerce operations, especially when you have cross-border business. Imagine all those crypto natives want to pay you a monthly subscription for your “Invest in crypto and retire early newsletter”. They have USDC in their Web 3 wallets. Gotta follow the money and take USDC!

Services like Yodlpay will let you pay and receive crypto without using the Visa & MasterCard rails. Or imagine you are Mercedes Benz and are working on things embedded finance; you might be allowing MB drivers to pay for petrol or electricity with a tap and go function on their phone, or collecting a car payment every time they drive 100km rather than monthly. One option is to connect to their Web 3 wallets and accept Stablecoin or eMoney. The folks at SAP whose systems are in huge numbers of corporates have seen movement coming. They are offering their “SAP Digital Currency Hub” to support stablecoin payments.

If we can transact ultra-cheaply using the new technology, then we might solve for the elusive “micro payment”; pay 50 cents to read an article in the Economist now if you are not a subscriber.

Another flavour might be using a tokenised money market mutual fund as a means of payment. Hold the asset, keeping your options open and keep earning some yield, then like with a truffle, slice off a small part to pay for a big-ticket item, like the kids’ school fees. That’s where the folks at Wisdom Tree are heading. They are giving us optionality; we don’t have to choose between holding cash or investing.

Thanks for reading. Please do let me know what you think of these notes. Feedback via the comments would be great.

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Author

Olaf is a liquidity and financial services expert. He is the founder of 3C Advisory  You can message Olaf directly here.