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Not so long ago, you knew where you were with money. A central bank like the Federal Reserve or the Bank of England issued dollar bills and pound notes. And you used them to buy and sell things.
If some technologists are right, then one of the newest trends in payments technology — stablecoins — are about to enter a “supercycle” that will swamp the world with more than 100,000 such payment systems within five years. Reconciling those coins — essentially crypto that is pegged to a real-world currency — will require a whole new financial infrastructure. No wonder the establishment is getting jittery. “This is going to involve a fundamental rewiring of the financial system,” one official told me.
Blockchain-based stablecoins have multiple progressive use cases. In countries with unstable currencies, a dollar peg for a stablecoin user might be attractive. In countries with slow or dysfunctional payment systems, they offer an efficient alternative. And for those who want to trade crypto, they are a route back to the fiat financial system.
The current US administration, meanwhile, has embraced stablecoins, seeing them as a valuable source of demand for US Treasuries, as well as a way to consolidate dollar dominance.
The disruption to the status quo may be healthy in many ways — expensive money transfer services will face cheap competition; credit card companies, long criticised for the high fees they charge merchants, could be similarly disrupted.
But for a global economy that relies on so-called fractional reserve banking — turning deposits from one set of bank customers into credit loaned to others — stablecoins also threaten to be deeply retrograde. Because stablecoins facilitate payment, but not credit, they could, if they lure deposits en masse, threaten banks’ funding and their ability to supply credit to the economy.
Central banks, especially those outside the US, are nervous. The European Central Bank, for example, fears a loss of sovereignty and monetary policy control, and is determined to launch its own digital currency as quickly as possible.
There are growing signs that commercial banks are scared of the upstarts, too. In an effort to stop stablecoins diverting their all-important deposit bases, some are going on the offensive. Using a blockchain as a distributed log (as stablecoins do), they are turning traditional deposits into “deposit tokens”. “If you think about digital assets and tokenised deposits with AI, you can suddenly redesign significant parts of financial services,” Lloyds Bank chief executive Charlie Nunn told the FT Banking Summit this month.
Lloyds is not alone. A pilot project with Britain’s other high-street banks is under way, overseen by the Bank of England, which wants to ensure interoperability. Sarah Breeden, deputy governor, has spoken of the need to prepare for a “multi-moneyverse” and the BoE last month launched a consultation on the proposed regulatory regime for stablecoins and tokenised banking.
So far, doing business with tokenised deposits remains a tiny part of the global banking industry. Even US behemoth JPMorgan, at the forefront of experimentation, is doing barely $5bn of tokenised payment volumes a day, versus up to $15tn in mainstream payments. But reformers reckon that if interoperability issues can be resolved then banks are in a strong position to exploit the efficiencies that digital tokens bring, while fending off stablecoin competition.
Banks’ multinational clients can, for example, transfer funds around their global operations 24/7, with no time lag and no need for a correspondent bank in a far-flung location. But bank clients, unlike stablecoin users, are protected by anti-money laundering rules, minimum capital and transparent reporting requirements, and a central bank backstop. Bank deposits — tokenised or traditional — qualify for interest payments, whereas stablecoins can’t pay interest under US and European law.
Token-based banking can also allow funds to be isolated in automatic escrow facilities to support asset sales, while “smart contracts” can automate certain payment triggers. Such facilities will more obviously modernise wholesale rather than retail banking, though Nunn is convinced the escrow option could smooth mortgage financing and house purchases.
All of this is at a very early stage. But even if policymakers preserve the fundaments of the current financial system, stablecoins and tokenised bank deposits look set to usher in a new era of digitised finance. The only certainty: life will get tougher for the Luddites.
