Original author: Eswar Prasad, Professor of Economics at Cornell University
Original compilation: Eric, Foresight News
The early revolutionaries of cryptocurrency aimed to break the monopoly of central banks and large commercial lending institutions on financial intermediaries. The grand goal of the original cryptocurrency, Bitcoin, and the blockchain technology behind it, is to bypass intermediaries and connect trading parties directly.
This technology aims to achieve financial democratization, allowing everyone, regardless of wealth, to easily access a wide range of banking and financial services. Emerging financial institutions will leverage this technology to offer competitive financial services—including customized savings, credit, and risk management products—without the need to establish expensive physical branches. All of this is intended to eliminate the old financial institutions that lost public trust during the global financial crisis and establish a new financial order. In this decentralized financial new world, competition and innovation will thrive. Both consumers and businesses will benefit from it.
But this revolution was quickly overturned. Decentralized cryptocurrencies like Bitcoin are essentially created and managed by computer algorithms, and it has proven that they are not viable as a medium of exchange. Their value fluctuates wildly, and they cannot process large volumes of transactions at low cost, making them unsuitable for everyday use and leading to their failure to achieve the intended goals. Instead, Bitcoin and other cryptocurrencies ultimately turned into what they were never meant to be—speculative financial assets.
The emergence of stablecoins has filled this gap, becoming a more reliable medium of exchange. They use the same blockchain technology as Bitcoin, but maintain value stability by being pegged one-to-one with central bank currency reserves or government bonds.
Stablecoins promote the development of decentralized finance, but they are inherently contrary to decentralization. They do not rely on decentralized trust mediated by computer code, but rather on trust in the issuing institutions. Their governance is also not decentralized, as users do not determine the rules through public consensus. Instead, the issuing institutions of stablecoins decide who can use them and how they can be used. Stablecoin transactions, like Bitcoin, are recorded in a digital ledger maintained by a decentralized network of computer nodes. However, unlike Bitcoin, it is the stablecoin issuing institutions that validate these transactions, not computer algorithms.
Payment Channel
Perhaps more ambitious goals are more important. Stablecoins can still become a channel for people from all income levels to access digital payments and DeFi, undermining the privileges that traditional commercial banks have long enjoyed, and in some ways narrowing the gap between wealthy and impoverished countries. Even small countries can benefit from more convenient access to the global financial system, reducing friction with payment systems.
Stablecoins do indeed lower payment costs and reduce payment friction, especially in cross-border payments. Economic migrants can remit money to their hometowns more conveniently and economically than ever before. Importers and exporters can complete transactions with foreign partners instantly, without waiting for days.
However, apart from payments, DeFi has become a stage for financial engineering, giving rise to many complex products whose value is questionable beyond speculation. DeFi activities have hardly improved the lives of impoverished families, and may even harm the interests of retail investors who are tempted by high returns and overlook risks due to their lack of experience.
Regulatory Transition
The recent legislation in the United States allowing various companies to issue their own stablecoins, can it promote competition and curb some disreputable issuing institutions? In 2019, Meta attempted to issue its own stablecoin Libra (later renamed Diem). However, due to strong opposition from financial regulators, the project was ultimately halted. Regulators are concerned that such stablecoins could undermine the effectiveness of central bank currencies.
With the changing regulatory environment in Washington and the arrival of a new government that is friendly towards cryptocurrencies, the door is now open for private stablecoin issuers. Stablecoins issued by large U.S. companies like Amazon and Meta, backed by their strong balance sheets, could sweep away other issuers. The issuance of stablecoins will enhance the power of these companies, leading to increased market concentration rather than intensified competition.
Large commercial banks are also adopting some new technologies to improve operational efficiency and expand their business scope. For example, converting bank deposits into digital tokens that can be traded on the blockchain. It is foreseeable that large banks may one day issue their own stablecoins. All of this will undermine the advantages of smaller banks (such as regional and community lending institutions) and consolidate the power of large banks.
international dominance
Stablecoins may also reinforce the existing structure of the international monetary system. The demand for dollar-backed stablecoins is the highest and they are the most widely used globally. They may ultimately indirectly enhance the dominance of the dollar in the global payment system and weaken potential competitors. For example, Circle, the issuer of the second most popular stablecoin USDC, has low demand for its other stablecoins (pegged to major currencies like the euro and yen).
Even major central banks are feeling uneasy. There are concerns that dollar-backed stablecoins could be used for cross-border payments, prompting the European Central Bank to issue a digital euro. The payment system within the Eurozone remains fragmented. While it is possible to transfer money from a bank account in Greece to a bank account in Germany, making payments in another Eurozone country using funds from a bank account in another Eurozone country is still not convenient enough.
Stablecoins pose a survival threat to the currency composition of small economies. In some developing countries, people may trust stablecoins issued by well-known companies like Amazon and Meta more than local currencies that suffer from high inflation and exchange rate volatility. Even in economies with reliable central banks and good management, people may find it hard to resist the temptation of stablecoins, as they are convenient for domestic payments as well as international payments, and their value is pegged to major global currencies.
Inefficiency of traditional payment systems
Why have stablecoins garnered such significant attention so quickly? One reason is that high costs, slow processing speeds, complex procedures, and other inefficiencies continue to plague international payment systems and even domestic payment systems in many countries. Some nations are considering issuing their own stablecoins to prevent their national currencies from being marginalized by dollar-backed stablecoins. However, this approach is unlikely to succeed. It would be better for them to first address the issues within their domestic payment systems and collaborate with other countries to eliminate friction in international payments.
Stablecoins may seem safe, but they actually hide many risks. Firstly, they could facilitate illegal financial activities, making it more difficult to combat money laundering and terrorist financing. Secondly, they may create independent payment systems managed by private companies, thereby threatening the integrity of payment systems.
Solution
The solution seems obvious: effective regulation can reduce risks, create space for financial innovation, and ensure fair competition by curbing the excessive concentration of economic power among a few companies. The internet knows no borders, so the effects of regulating stablecoins at the national level are far less effective than a collaborative model involving multiple countries.
Unfortunately, in a time when international cooperation is lacking and countries are actively maintaining and promoting their own interests, such an outcome is unlikely to be achieved. Even major economies like the United States and the Eurozone are acting independently on cryptocurrency regulatory issues. Even if a more coordinated approach is taken, smaller economies will find it difficult to participate in decision-making. These countries have weak financial systems, limited regulatory capacities, and a strong hope for a sound regulatory framework, yet they may be forced to accept rules imposed by major powers that hardly consider their own interests.
The role of stablecoins lies in revealing the inefficiencies that are commonly found in the existing financial system and demonstrating how innovative technologies can address these issues. However, stablecoins may also lead to greater centralization of power. This may give rise to a new financial order - one that is not as envisioned by cryptocurrency pioneers, as a system filled with innovation and competition, with a fairer distribution of financial power, but rather one that brings greater instability.
