International | 11:00 AM
A lot is happening in e-currencies and stablecoins. Justin Thomson, Head of the T. Rowe Price Investment Institute, offers some insights and perspectives.
By Justin Thomson, Head of the T. Rowe Price Investment Institute
When I first wrote about cryptocurrencies in March, I observed that despite several “near death” experiences, the asset class has shown no signs of going away. I concluded that crypto is not so much a “volatile” asset class in the typical sense, but rather a beta asset on steroids.
In effect, holding crypto has been the investment equivalent of bungee jumping: You have to be prepared for a major adrenaline rush but, providing you don’t capitulate at the bottom, you get out alive—and then some.
The trouble is, for those of a nervous disposition (or with an existing spinal injury), this may not be an attractive proposition. Furthermore, Economics 101 teaches us that a currency should be a stable means of exchange—crypto, as it has evolved so far, lacks the stability to be that medium of exchange.
This is changing, however. In July, the U.S. Congress passed the Guiding and Establishing National Innovation for U.S. Stablecoins (GENIUS) Act, creating a legal framework for U.S. dollar-denominated, privately issued stablecoins.
Stablecoins are digital assets or blockchain-based tokens that are backed by reliable and highly liquid assets such as the U.S. dollar or U.S. T-bills, meaning that they are anchored to a stable monetary value.
Following the introduction of similar laws in Japan, Abu Dhabi, and the European Union, the GENIUS Act brings the U.S.—and by extension the world—closer to the digitization of national and cross-border payment systems.
The act ushers in some consumer safeguards: Private issuers have to segregate and publish reserve backing for the issued stablecoins; stablecoins have a senior ranking in the capital stack in case of issuer insolvency; and issuers are subject to marketing and consumer protection rules and must comply with anti-money laundering and sanction laws.
In effect, this means that you get all the convenience of friction-free transactions on blockchain with a stable means of exchange. Genius indeed.
In search of stability
It feels like a seminal moment, with the GENIUS Act setting stablecoins on a path to play a big role in the future of money globally. But, as always with technological innovation, there are caveats.
One is that a digital currency backed by fiat money is still fiat money—and fiat money is based on trust, both in government policy and in the inflation credibility of the issuing central bank.
A useful reference point here is the eNaira, Nigeria’s publicly issued stablecoin, which has been largely shunned by consumers who have opted instead to buy privately issued dollar-backed stable coins.
One of the reasons why take-up of the eNaira has been so sluggish (fewer than 0.5% of Nigerians used it within a year of launch) is that it is only a digital version of the underlying fiat currency (the naira), in which trust has sharply eroded in recent years.
An alternative way of providing stability is to back a digital currency with a hard asset such as gold or silver—or even cheese (Italian bank Credito Emiliano is famous for being backed by wheels of parmigiano reggiano).
There are algorithmic methods, which use supply and demand formulas to keep the value close to the reference asset. However, these are generally less proven and involve more risk.
It is also important to note that the consumer safeguards provided by the GENIUS Act mentioned above fall considerably short of those applied to other financial products. If stablecoins are successful, they will eat into the business of banks while being regulated with nowhere near the same degree of rigor.
There is also dissonance around the potential “anarchy” of multiple private sector entities issuing currency. From the blockchain/crypto perspective, we’ve finally reached interoperability with ease of use.
However, with the coming proliferation of stablecoin launches from new issuers, a practical concern is whether multiple competing issuers with their own platforms and on/off ramps could create competing walled gardens that erode the efficiencies that stablecoins bring to payments.
There is both negative and positive precedent here. The mid-19th century era of “free banking,” ushered in by President Andrew Jackson’s successful campaign against a federal proto-central bank, resulted in chaotic monetary conditions as each bank issued its own currency, which traded at varying exchange rates to each other.
However, commercial banks issuing bank notes in Scotland and Hong Kong is still an accepted and orderly norm.
A matter of trust
Much comes down to the issue of trust. The Bank for International Settlements, the umbrella body for central banks, has warned that the unchecked rise of stablecoins could threaten the public’s trust in money.
For users to trust that stablecoin value will not budge, they need to know its collateral is verifiable, liquid, and of high quality. And while adequately backed stablecoins offer some advantages over “trad-fi” currencies (particularly regarding the speed and cost of transactions), such pegged assets are always subject to runs by holders seeking to convert holdings back into dollars or whatever currency is backing it.
Both of the main stablecoins—Tether and USDC—have briefly fallen below their USD 1 peg. These risks are not novel in modern finance. Money market funds have “broken the buck” in periods of severe market stress, such as in 2008.
An alternative vision of the new state of money is central bank digital currencies, which are directly issued and regulated by the central bank and akin to a publicly issued stablecoin.
This is the route that both the eurozone and China are going down. Should either of these catch on, the hegemony of the U.S. dollar as the world’s reserve currency may finally be challenged.
Currently, there are around USD 250 billion of stablecoins in circulation globally, virtually all linked to the dollar. The successful creation of a digital euro will be a key litmus test: If the European Central Bank gets it right, it will show that a non-U.S. dollar public sector option is viable.
At present, I think there is much stablecoin FOMO. As my colleague Blue Macellari, our in-house crypto specialist, jokingly says: “Who doesn’t want to launch a stablecoin? I would if I could!”
As stablecoin enables easy crypto trading, the lasting benefit of stablecoins could, therefore, be in connecting investors to other parts of the cryptosphere.
Whether stablecoin becomes the dominant or even a significant means of payment outside the world of digital assets is moot: There is now a clear path to a sunlit upland of payment modernization, enabling instant, low-cost, and secure transactions, including 24-hour trading and financial inclusion as stablecoins bring digital money to unbanked populations.
The technology is there, and the regulatory framework is falling into place—however, the trust required to finally push stablecoins into the mainstream may take a little longer to gain.
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