Commercial stablecoin issuance – Part I: Considerations and benefits

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Source: Quant

Banks around the world – including some well-known global brands – have begun issuing their own digital currency known as commercial stablecoins. The benefits are significant but it’s not all plain sailing: there are a variety of factors to consider before implementing.

Not to be confused with algorithmic stablecoins, commercial stablecoins are a form of digital currency whose value is tied to the price of traditional fiat currencies. The purpose of this 1:1 pegging (which can also include other assets such as commodities) is to minimise the volatility typically associated with cryptocurrencies.

The first known stablecoin was BitUSD, released on the BitShares blockchain on 21 July 2014. Since then, the market has grown to approximately $153 billion, with Tether (USDT), USD Coin (USDC) and Binance USD (BUSD) the three most dominant stablecoins by market capitalisation.

Global banks are exploring the virtues of minting their own stablecoins, as awareness that the underlying blockchain technology has the potential to bring numerous benefits to both wholesale and retail customers, begins to grow. And regulations begin to take shape. This is evidenced in Japan, for example, where its parliament has passed legislation permitting yen-linked stablecoins. Mitsubish UFJ Trust and Banking Corp plans to launch Progmat Coin, once the legal framework is finalised.

In March 2022, ANZ became the first bank in Australia to mint its own stablecoin, ‘A$DC’, and execute the country’s first stablecoin payment; a AUD30 million payment to a private wealth manager. While in the United States, a group of five banks is planning to issue a stablecoin it calls USDF, in response to concerns over nonbank-issued equivalents.

Ian Taylor is head of digital assets at KPMG. “My sense is that, based on conversations we have had with financial institutions, it is now on their radar,” he says. “Their innovation teams are looking at the technology and thinking about how they can improve their own processes.

“We are working a growing number of fintechs that have already publicly announced they will be rolling out stablecoins within their merchant networks.”

Factors to consider
As global bank interest in stablecoin issuance begins to build, there are several factors to consider. According to PwC, a viable stablecoin ought to have four key characteristics.

1. Attestation
An attestation report confirms the existence of the underlying assets which back the stablecoin. PwC advises that the reporting should be completed by a certified professional services organisation.

2. Nature of reserve holdings
A well-designed stablecoin requires a range of high quality, liquid assets for collateralisation purposes.

3. Regulatory oversight and registrations
Both the stablecoin and the legal entity responsible for its operation need to fall under the imprimatur of a regulatory body and ought to be established in a well governed jurisdiction with a well-established legal system.

4. Technology
PwC advises that the overall usefulness of the stablecoin depends on how well its underlying technology integrates with conventional, non-blockchain technologies.

“Over the course of the next few years, I would expect to see some stablecoin issuance pegged to the euro and/or sterling, or at least start being tested. Multiple banks have taken an interest in crypto and DeFi, and in possible stablecoin issuance now that EU regulation has been finalised,” comments Teunis Brosens, Head Economist for Digital Finance and Regulation at ING.

On the regulatory point, any proof of concept project within a bank or payment services provider will need to ensure that the right resources are in place to monitor bank regulatory developments and prepare accordingly.

In a paper authored by Deloitte, ‘So, you want to be a stablecoin issuer?’ its authors suggest that in the near-term, “banks should work through the range of possible scenarios in which stablecoins could unfold, engaging strategy, regulatory policy, product innovation and technology teams.”

In Europe, stablecoins are subject to the Markets in Crypto Assets (MiCA) Regulation proposal launched by the European Commission last year. Currently, MiCA prohibits the issuance of algorithmic stablecoins.

“In the UK we have the Financial Services and Markets Bill. Andrew Griffith, the UK government’s city minister, said that it should be written into law by next Easter,” confirms Taylor. He expects more financial institutions to start applying for stablecoin licences once these regulatory guardrails are in place.

Two types of stablecoin are deemed appropriate: 1) asset-referenced tokens (‘ARTs’), which are linked to a basket of fiat currencies or commodities, and 2) e-money tokens, which are linked to a single underlying fiat currency.

Identify the benefits before pulling the trigger
For any working group tasked with scoping out the development of a stablecoin, there needs to be firm-wide agreement, led by senior management, on how and in what capacity such a stablecoin would be used. A clear distinction needs to be made between retail and commercial banking. So far it seems that the most effective stablecoin use cases apply to the wholesale space.

JP Morgan’s JPM coin, for example, is restricted to wholesale clients only. This allows it to process 24/7 cross-border payments and has led to increased efficiency and reduced costs. More examples will doubtless follow.

But while such a stablecoin is fine for customer-only cross-border payments within the JP Morgan ecosystem, it is not possible on a bank-to-bank basis. A JPM coin could not process and settle payments with a Barclays coin, for example, as this would mean exchanging one bank’s credit for another bank’s credit.

For an interoperable cross-border payment mechanism to work it requires digitised cash and the credit quality of central bank money. Banks may still choose to develop their own stablecoins for various reasons, but in the context of capital markets – such as improving trade finance cost and efficiency – a more consortium-led approach might evolve.

In 2019, a global group of 15 banks including BNY Mellon, Commerzbank and Credit Suisse came together to establish London-based Fnality International, which aims to bring central bank money into a digital tokenised form. This will allow banks to significantly reduce their intraday liquidity requirements and will, crucially, overcome the credit risk conundrum referred to above.

In February 2022, three UK fintech firms and two European banks – Santander and NatWest – successfully completed a pilot POC involving the execution and settlement of a tokenised security. The payment leg was settled in a test central bank money-backed digital asset, called Ecosystem TestNet.

Christopher Agathangelou, Head of Digital Capital Markets & Flow Credit at NatWest said at the time: “Distributed ledgers and digital assets will help level the playing field by lowering the barriers to entry to financial markets for both large frequent issuers and smaller enterprises.”

For wholesale banking, this type of ecosystem can offer the advantage of processing and settling cross-border payments instantaneously on the blockchain, stripping away many of the time-intensive, manual processes and helping payment systems move towards a T=0 capability.

“You need settlement finality. Once the payment settles, it’s done. There’s no recourse. Whatever system you have on chain needs to provide that legal protection,” says Fnality CEO, Rhomaios Ram. He believes that banks could save “as much as USD16 billion a year on liquidity cost provisions”.

Other key benefits to banks pursuing stablecoin capabilities include:

  • Low-cost B2B payments to business customers, who are able to use a digital dollar (or euro) payment and benefit from significantly improved payment settlement times
  • Greater speed, traceability and transparency in global trade finance
  • Ability to develop DeFi market solutions: Customers who hold stablecoins will be able to earn higher interest (referred to as yield in DeFi) by lending their digital assets. This could help banks develop more attractive savings programmes for retail investors

This is the first in a two-part series of articles on stablecoin issuance. The second in which we examine the risks will be published later this month. Subscribe to ensure you don’t miss it.

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