1 month ago

    Stabilizing the Volatile: The Rise of Stablecoins in Crypto Banking

    Stabilizing the Volatile: The Rise of Stablecoins in Crypto Banking
    Table of contents

      The advent of stablecoin investment products is one of the most incredible developments at the junction of traditional finance and digital assets.

      The launch of stablecoins establishes a new paradigm shift in the banking industry by disrupting the traditional business model and impacting the financial customer experience. Financial firms can play a key role in enhancing related opportunities and handling risks.

      With pilot programs happening across the globe, stablecoins are attracting the attention of many financial institutions. However, most institutional players want to understand whether the stablecoin trend is a threat or bailout for the industry and how they can navigate the paradigm shift.

      Market Influence                                                                    

      The global banking industry is growing, and its future looks bright. Despite economic challenges like the conflict between Russia and Ukraine, the sector was valued at $614.62 billion in 2023 and is expected to reach a massive $1,231.49 billion market size by 2027. This growth contributes to the rising adoption of digital banking, as more customers want flexible and personalized services.

      The banking sector is crucial to the modern economy. As a vital credit supplier, it provides money for businesses and people to meet their financial obligations. Neobanks, fintechs, and global banks embrace stablecoins to enhance their offerings and meet customers’ changing needs.

      Bitcoin played a massive role in transitioning digital assets into the financial mainstream, with the US SEC recently approving the trading of spot Bitcoin ETFs in the traditional financial markets. Stablecoins have become critical in enabling crypto asset trading, with global adoption of US dollar-backed stablecoins witnessing exponential growth and transactions almost hitting $10 trillion in 2022.

      Increased competition

      This year, the global banking industry will likely experience some twists and turns. A mix of economic uncertainties and a slowdown in the global economy may keep banks and financial firms on their toes. Although efforts to address inflation are showing progress in some places, other issues, such as geopolitical tensions, shifting trade dynamics, and supply chain disruptions, complicate matters.

      A potential paradigm shift in the perception and application of digital assets will likely impact the US dollar’s global dominance. Rising interest in assets like increasing demand for Bitcoin, growing trading volumes of stablecoins, and the upsurge of CBDCs pose a significant challenge to the US dollar’s dominant role in international trade and finance.

      Despite the US contributing 25% to the world’s economic output, the dollar remains the largest global reserve currency, holding almost 60% of global foreign exchange reserves. However, this dominance is witnessing heightened scrutiny, with some countries and regional blocs exploring alternatives. While China is advancing its cross-border interbank payment system CIPS to internationalize Yuan use, the European Union is working on increasing the euro’s role in international trade. Regional blocs like the Eurasian Economic Union (EAEU), SCO, ASEAN, and BRICS express interest in using stablecoins backed with local currencies for payment settlements and trade invoicing. This shift signals a clear move toward decreasing dollar dependency across the world.

      As countries and regional trading blocs seek alternatives to the US dollar, digital ledger technology (DLT) based currencies, including stablecoins, are emerging as viable options, impacting international finance and trade. The shift, fueled by global geopolitics, competition, and US foreign and monetary policies, drives the overall dollar usage decline in central bank reserves and cross-border transactions.

      Digital payments systems

      An increasing number of neobanks, fintechs, and traditional banks are embracing stablecoins in their business operations to offer new and unique services, attract a broader customer base, and stay relevant in the evolving financial landscape.

      During the past year, many financial institutions announced various blockchain initiatives, including cross-border payments, CBDCs, asset tokenization, post-trade settlement, and DeFi, which are basically in stablecoins. Late last year, JPMorgan successfully tested a blockchain-based deposit token for cross-border payments while several US banks developed the USDF Consortium to establish a joint stablecoin.

      Led by Russia, BRICS nations are actively promoting digital payment systems and financial inclusion. With their decentralized nature and potential for facilitating cross-border transactions, stablecoins align with the objectives of these countries to modernize financial infrastructure and expand access to financial services. BRICS countries seek to enhance financial inclusion in their jurisdictions by developing stablecoin-based payment solutions or integrating cryptocurrencies into existing digital payment systems.

      The BRICS nations, consisting of Brazil, Russia, India, China, South Africa, the United Arab Emirates (UAE), Iran, Egypt, and Ethiopia, collectively represent a considerable position in the global population and economy. Their extensive consumer bases, technological developments, and economic growth make them potentially influential crypto markets. These nations have indicated more openness towards crypto, exploring regulatory frameworks, and promoting innovation in the blockchain landscapes, resulting in positive health of the overall crypto ecosystem, increased market development liquidity, and transaction volumes.

      Amid the slow-moving trend of traditional banking, Rosbank, one of Russia’s main banks, recently announced plans to launch a facility enabling importers to settle cryptocurrency transactions. The development came after Alfa Bank, one of Russia’s largest private banks, became the fourth financial institution in the country, allowing customers access to digital assets from the banking app.

      India’s biggest banks, including HDFC Bank, ICICI Bank, and Axis Bank, allow cryptocurrency transactions through the UPI platform. Mid-last year, JPMorgan partnered with these Indian banks to enable real-time settlement of dollar trades on the blockchain, thereby eliminating the lengthy transaction processing times that typically extend over several days.

      Last year, South Africa’s Standard Bank started making significant progress in leveraging blockchain and smart contracts via its Aroko payment platform. South Africa’s First National Bank also disclosed plans to adopt a blockchain-based system to issue digital title deeds for its customers’ real estate assets.

      Last year, First Abu Dhabi Bank (FAB), the largest commercial bank in the United Arab Emirates (UAE), completed a pilot experimenting with JPMorgan’s Onyx blockchain-based payment platform for cross-border transactions. FAB’s move demonstrates the bank’s commitment to leveraging blockchain technology to provide innovative solutions to its customers around the payments landscape, especially cross-border payments.

      Through a partnership with blockchain startup Kuknos Company, four banks (Parsian Bank, the Bank Pasargad, Bank Melli Iran, and Bank Mellat) operating in Iran rolled out a gold-backed cryptocurrency popularly known as PayMon to be used for cross-border payments purposes as well as tokenizing the banks’ assets and properties. The development demonstrates the evolving Iranian cryptocurrency ecosystem amid civil unrest and global economic sanctions that limited its access to foreign financial markets. Iran approved the use of cryptocurrency for imports as a measure to circumvent US sanctions that have significantly weakened the national currency and devastated the economy. The new regulations allow for importing any goods to the country, contributing to the upsurge of demand for crypto, which is less regulated and can be used in transactions by locals.

      Growing interest in CBDCs

      The rapid adoption of stablecoins has also contributed to the global interest in CBDCs, with 130 nations actively exploring them as of mid-last year. A recent OMFIF survey shows that 41% of central banks are expecting a CBDC to be fully operational by the year 2028. That could accelerate the overall prevalence of these digital currencies globally. By the end of last year, over 11 countries already launched their CBDC pilots.

      The growth of CBDCs presents a threat to the current banking system, which explains why banks want to get involved in the issuing process and launch stablecoins-related products. Thanks to the development of CBDCs, business competition is intense, as banks and fintechs compete with a new player ─ the central bank. Incumbent banks and fintechs are keen to innovate and adapt their business models. They focus on investing in new technology and processes to remain competitive, expand their offerings, and become more regulated to gain wider acceptance.

      Addressing market volatility

      The crypto ecosystem is well known for volatility, the biggest barrier to an investor’s adoption. Stablecoins, a new form of crypto money imitating traditional and stable currency, is the answer to an unstable cryptocurrency for transactions that impact buyers, businesses, and financial institutions. Creating stablecoins has been a way to increase adoption and enable valuable startup growth in the ecosystem.

      Crypto native firms Tether and Circle applied this principle by “linking” their USDT and USDC stablecoins with the US dollar. Some other popular stablecoins backed by fiat include Binance (USD), TrueUSD (TUSD), and Pax Dollar (USDP). The innovation is to make crypto payments more efficient and accessible, without concerns about the wild swings of traditional cryptocurrencies, and significantly decrease transaction costs.

      Another good example is JPMorgan Chase bank, which pegged its JPM Coin to the dollar. Last year, PayPal launched a US dollar-backed stablecoin to facilitate payments, becoming the first major financial technology firm to embrace cryptocurrencies for payments and transfers.

      Corporations (like Visa, MasterCard, PayPal, IBM, etc.) are increasingly embracing stablecoins or stablecoin-like financial products and services. Some financial services businesses opt for partnerships to offer stablecoin services without going through the complex process of managing ongoing compliance or acquiring new regulatory approvals.

      New services and products

      Banks and financial institutions use stablecoins to develop financial products. Others want to integrate stablecoins into their existing services and products to facilitate more efficient investment in various cash instruments, foreign exchange, and securities. This move came after the US Federal Reserve Board recently said replacing physical cash with stablecoins would lead to more credit intermediation and enhance the efficiency of payment services.

      Several financial institutions use permissioned blockchains to develop reserve-backed tokens (tokenized deposits) to enable their institutional customers and clients to conduct efficient wholesale and B2B transactions. JPM Coin is an excellent example of stablecoin that JPMorgan customers use to facilitate instant settlements, and JPMorgan Chase bank utilizes it to manage internal liquidity.

      The crypto-native DeFi platform Aave enables customers to use cryptocurrencies as collateral and receive a stablecoin loan at attractive interest rates. Bank Frick recently rolled out staking services, enabling customers to lock up their stablecoins for a period to support blockchain network operations and, in return, generate passive income. Other financial firms are considering using the same strategy to facilitate the issuance and management of commercial transactions based on a deep understanding of risks and their management frameworks.

      The growth of digital asset custody services, issuance, lending, and payments present exciting avenues for banks and other financial managers to explore. Digital assets like stablecoins can enable the development of new investment solutions for numerous business lines, such as foreign exchange, equities, rates, and fixed income. However, financial companies and banks must make choices regarding capital adequacy and bank reserve requirements and cooperate with regulators.

      Increased regulations and risk management

      Many financial firms, like PayPal or the French giant Societe Generale, are launching stablecoins to facilitate applications such as peer-to-peer transactions and cash management. However, the potential for stablecoins to play a crucial and growing role in the finance and payment industry has led to growing regulatory scrutiny over recent years.

      Across 2023/2024, new regulatory and legal requirements heightened for stablecoin issuers, expecting these financial institutions to manage operational risk and provide an equivalent level of protection against loss of value and confidence. For instance, the Markets in Crypto Assets (MiCA) regulation has put stablecoin issuers in the EU into a greater task, requiring them to segregate and safeguard assets, ensure token holders’ redemption rights, and maintain sufficient reserves, among other responsibilities.

      Other countries are making similar steps. Singapore has already established a regulatory framework for stablecoin issuers. China and the UK plan to keep pushing for legislative updates to create the basis of regulatory frameworks for stablecoins. The UK’s central bank continues to progress towards fixing the potential systemic risks associated with stablecoins, which could have wider implications for the broader crypto-asset market and the traditional financial system.

      Establishing these regulations and other global frameworks not only assists in developing clarity but also gives life to new requirements for stablecoin providers. Banks and financial institutions engaging in stablecoin issuance are subject to rigorous oversight.

      Conclusion

      Stablecoins present the potential to establish more efficiency in almost every aspect of financial firms’ day-to-day activities.

      As they approach these new options, financial institutions must consider numerous implications: operational and cybersecurity resilience, efficiency, safety, and regulatory framework of stablecoins.

      However, with financial firms starting to utilize underlying distributed ledger technology for transacting stablecoin products, the priority for these investment managers is to engage, understand, and act.

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