Stablecoins and the real world of payments

The plumbing matters more than the peg: Part 1

Why should stablecoins garner so much attention in the world of payments? After all, stablecoins are a niche product invented as a capital-markets tool for crypto traders. Early versions that built off of algorithms, like Terraluna, blew up. Those tied to US dollars or other fiat currencies have fared better. The global market for stablecoin tokens is now valued at $255 billion, with 99 percent of those pegged to the dollar. Compared to other financial markets, it’s a tiny number.

Although the crypto industry likes to tout figures of transaction volumes up to $35 trillion annually, this does not reflect real-world payments. It reflects internal trading in crypto markets, for which stablecoins were invented; much of which may be illicit, either wash trades or money laundering. In February, McKinsey & Company estimated annual real-world payments using stablecoins at around $390 billion.

That sounds like a lot, but it’s only 0.02 percent of real-world payments – today. It is already 10 times greater than stablecoin payments volumes from five years ago. US Treasury Secretary Scott Bennett last year predicted stablecoin volumes to reach $3 trillion by 2030. Beyond B2B cross-border payments, other use cases might include payroll, billing, and capital markets, in which stablecoins provide the cash leg to tokenized asset transactions.

For the little guy?

When it comes to payments for real-world goods and services, the industry likes to talk up the financial-inclusion story. And it’s not wrong. Stablecoins can deliver real benefits to companies that are small or national. This feel-good narrative downplays the role of big corporate banks that already bend over backwards to provide premium services to multinational corporations. It puts fintech and crypto startups in the cockpit.

The status quo network of correspondent banks was indeed designed for MNCs. Even for them, payments involve hassle: the vagaries of the system are such that physical goods may well reach their destination before the exporter receives their money. They are also on the hook to payment processors for interchange fees behind credit and debit cards.

For a multinational, correspondent networks and payment fees are just a cost of doing business, and absorbing costs can become a competitive advantage. For everyone else, slow and expensive payments are a business impediment.

Ah, correspondent banking

This doesn’t mean correspondent banking is a failure. Au contraire! It works very well – for banks. Since the 1970s they have agreed on SWIFT messaging standards, which identifies senders and receivers of money, defines the purpose of the payment, and other data points that are necessary to moving money through a chain of correspondent banks. Each bank has to run its own compliance checks, though.

This duplicative process adds delay, and cost (there are plenty of opaque moments where banks convert currencies for a juicy fee). And although compliance safeguards the entire system, small businesses can get crushed if faulty paperwork or suspicions about dodgy transactions prompts a bank to freeze the cash.

The disadvantages to smaller B2B transactions as well as individual remittances reflect the origins of correspondent banking as a service for large corporations. Today remittances and smaller B2B transactions are part of the mix, thanks to digital services, but MNC volumes still account for 47 percent of cross-border payment flows, and the highest value.

Just as the greatest value in cross-border payments remains with MNC customers, so too the eventual prize for stablecoin issuers will be these same giants; but financial inclusion is what gets the ball rolling. It also makes a crypto product sound warm and fuzzy to regulators.

The fintech money operators

This follows the first wave of fintech disruptors, which serve segments that were previously excluded from correspondent networks, or for whom making cross-border payments was especially expensive. This focus on smaller B2B and remittance users has enabled fintechs such as Airwallex, Revolut and Wise to make FX and payments instant and cheap.

But they operate on correspondent banking rails. The actual settlement time and cost hasn’t changed. What’s different is the user experience (UX). The fintechs open bank accounts in many countries, and handle the settlement behind the scenes while the customer appears to enjoy an instant transfer with just a few easy clicks. This works by pre-funding all of these accounts.

It’s an expensive business. Depending on local licensing, these money operators must hold initial capital and operating, risk-based capital. They hold high cash reserves. That’s money that cannot be lent out (these aren’t licensed banks, although Revolut has become one in Europe). They earn revenues through interchange fees on debit cards, subscriptions to upgraded services (travel perks, for example), and earning interest on customer deposits. They also charge companies a fee to integrate into their services with an API.

Stablecoin issuers

Enter stablecoin issuers. Their sole means of revenue is earning interest on deposits. They also face distribution costs: Circle pays a hefty cut of revenues to crypto exchange Coinbase. Revolut today is very profitable thanks to a diversified line of business, while Circle – the second-largest stablecoin issuer, and by far the largest operating in a regulated environment – is still loss-making. Its revenues are also dependent on interest rates.

These businesses promise faster, better, cheaper for cross-border payments. They need to offer the immediacy and low cost of fintech money operators, while making the transactions happen in actual real time, by combining the messaging function with the movement of value. By using blockchain rails, stablecoin issuers are meant to create a lower cost of doing business, and bypass the heavy reconciliation processes of correspondent banking. If they can offer a yield on their tokens, they will be able to build new product lines.

It’s not necessarily about wiping out money operators. Revolut, building on its FX business, now adds stablecoins and crypto to its currency brokering; its goal is to be a retail hub for digital assets, so these businesses can be mutually reinforcing.

Sandwich or spaghetti

This is an example of the “stablecoin sandwich”, in which two fiat currencies serve as the bread, with a stablecoin in the middle as the meat: it is connective tissue in which the tokens are transacted momentarily rather than held.

In this example, Revolut is coordinating the two fiat slices and someone else’s stablecoin filling, perhaps Circle’s USDC. In other cases, such as with Ripple, its token XRP is the filling while Ripple also coordinates the XRP/fiat transaction among its bank counterparties. Stripe is taking a bite of its own, integrating stablecoins such as USDC into its Optimized Checkout Suite so merchants can instantly and cheaply settle into their own fiat currency.

Other players are aiming to build closed-loop systems using their own stablecoins: not a sandwich but a bowl of spaghetti (our play on the term for messy middleware, only in this case maybe there’s just one noodle instead of many).

Walmart is experimenting with its own stablecoin, to be used in a closed loop among its own customers, displacing credit card transactions which come with a 3 percent interchange fee that Walmart must pay. It wants to integrate blockchain finance with rewards, instant refunds, and other customer-friendly services, while saving a lot of money. JP Morgan’s Kinexys unit operates JPM Coin to move client moneys internally across global accounts instantly and efficiently.

Endgame

These examples point to the eventual power of stablecoins, not as serving the little guys, but by embedding themselves in corporate treasury workflows. The fintech money operators were designed for SMEs and individuals, and that’s where they’ll stay. Stablecoin players today talk the same language but they’re ultimately building for the highest-value clients in cross-border payments.

Despite these encouraging initatives, stablecoins have a way to go before they become mainstream. Adoption won’t just happen organically until lingering issues are addressed. Stablecoins emerged from the crypto world and they bring crypto baggage.

The easiest challenge to tackle is crypto’s notoriously bad UX, reliant on seed phrases, clunky wallets, and confusing interfaces that don’t integrate well into, say, a user’s bank statement. These are addressable design challenges.

There remain more fundamental challenges, which our next article will explore: legal status, transparency/privacy, liquidity, and resilience.