Will Stablecoins Change International Banking and Remittances Forever? - Fintech Breakdown Issue 9

First, apologies for the long hiatus. I recently resumed my Masters in Commercial Law at the University of Exeter and it has been a real hassle settling in. You can read more about that on my LinkedIn post about it HERE if you want. Part of that experience is the basis for this newsletter, though, so it’s not all bad???.?

When I arrived last month, I had zero Pounds with me. In the hustle to get my COVID test results and make other last-minute arrangements, I had completely forgotten to get at least some local currency to tide me over till I could get an account and card for local payments. Nonetheless, within 72 hours of my arrival, I had a physical card in my hand, fully activated and ready for use, funded from my local bank account back in Nigeria.

The physical card aspect was quite straightforward – I simply opened an account with a fintech company, completed their verification requirements, and requested a card. Funding the account was the real issue. Since I didn’t have British Pounds in my Nigerian account that I could wire over to the UK, there was no easy way to convert the Naira in my Nigerian account to Pounds that I could spend in the UK.

That is, except stablecoins.?

Using a cryptocurrency P2P exchange, I purchased stablecoins with Naira and then sold that for British Pounds, receiving the value into my account within less than 10 minutes in total.?

What Are Stablecoins and How Do They Work?

Stablecoins are one of three baskets of cryptocurrencies (my categorization, to make it simpler), with the other two being crypto tokens like Bitcoin, Ethereum, etc., and Central Bank Digital Currencies like the Chinese digital yuan and Nigeria’s proposed e-naira.?

Crypto coins are highly decentralized, with prices that typically fluctuate wildly, thus making them unsuitable for day-to-day transactions while CBDCs are digital versions of national currencies, under the tight control of the central banks which issue them (We discussed CBDCs extensively in?Issue 2). Stablecoins tread the middle path, offering the stability of national currencies while also being under less government control and having more anonymity (for now, at least). Also, they have simply been more advanced. While countries are still figuring out how to launch digital currencies, several stablecoins have established themselves, with more than $113 billion in coins already issued.?

USDT (issued by Tether), BUSD (issued by Binance), and USDC (issued by Coinbase) are the most popular, accounting for the lion’s share of the market.?

The companies that created the coins do so by accumulating an asset base in fiat currency (eg. The United States Dollar) and then creating a coin representing each unit of the fiat currency. For instance, where the company has 1 million dollars in the bank or other assets, it will be able to create 1 million USDC tokens and make that available for sale. The risk here lies in potential mismanagement of the underlying assets or fraud with the actual tokens.?

Aside: When you think about it, the same principle applies to other forms of “digital money” as well. Unless you have actual currency notes and coins in your hands, every other kind of money – debit/credit card, money in your account, digital wallets, etc. is not cash. Rather, it’s debt owed to you by the issuing organization, whether that’s a bank or fintech company. They, too, secure your funds by investing in assets (deposit with the central bank, commercial banks, or other assets such as treasury bills, loans, etc.)

How Stablecoins Could Fix Remittances

When people want to send money from one country to another, the most important things for them are typically how fast the money can get to the person whom they want to pay, and well as whether or not they will be paying fees, and how much those fees would be. People want to get their money as quickly as possible and lose as little value in fees as possible in the process.?

Stablecoins offer both things. First, because the funds are held in a central database, there’s less friction in transfers compared to sending money from a bank in one country to a bank in another, with different systems and subject to different regulations and policies. While international wire transfers take between 1 and 5 working days, stablecoin transfers often take only a few minutes.

When it comes to fees, stablecoins are much cheaper than wire transfers as well. International wire transfers typically cost around $45 and $50 to send and between $15 and $25 to receive, meaning that the transacting parties lose money on both ends. With stablecoins, only the sender pays a fee, and although that fee can vary depending on the stablecoin in use and the network used for the transfer, it’s always much lower than the fees for a wire transfer.?

So, we can all ditch the banks and begin using stablecoins for transfers, right?

Well, yes…and no.?

Potential Hitches

While you can use stablecoins for transactions globally, they continue to be in a grey legal area in many countries. For instance, my Nigerian bank with which I paid for USDT would be obligated to shut down my account if they discovered I had used it to pay for cryptocurrency because while transacting in cryptocurrencies isn’t illegal for citizens, the Central Bank of Nigeria has issued a policy barring financial institutions from facilitating crypto transactions of any type. The ban is similar to the one issued by the Chinese government recently.

In short, in some countries, using stablecoins would be a crime or a violation of your financial institution’s terms and conditions, which could lead to losing your account or other consequences.?

Although the goals of the bans were announced as being to protect citizens, they have had little effect on the volume of transactions, but the effect has been to reduce regulatory oversight and further endanger market participants. For one, there’s less regulatory oversight so there’s likely to be more criminal activity, and victims of scams will likely have no legal recourse.?

Clearly, the bans have been counterproductive, and governments are bound to acknowledge that sooner or later since the imperatives for regulating financial transactions (preventing illegal activity especially) still exist. It’s certain that there’ll certainly be a global shift toward regulation, as we have seen in countries like Hong Kong, Japan, and the United Arab Emirates. International organizations like the International Monetary Fund have also prodded countries toward an “accept, integrate and regulate” strategy.?

Regulatory Approaches

There have been several proposals on how to regulate stablecoins. The US and Nigerian Securities and Exchange Commission indicated they might consider them securities, several bills have been initiated, including one in the US to restrict issuance to licensed banks. So far, it’s clear that stablecoins do not fit neatly into any existing financial paradigm, and new rules will need to be created. Although what the regulators in each country will decide on is bound to differ, the following are some of the key issues that have emerged and will certainly be addressed by everyone:

AML/CFT – Anti-Money Laundering and Countering the Financing of Terrorism are crucial issues that all financial institutions are bound by law to monitor and address whenever they spot suspicious transactions. Even though cryptocurrency is focused on anonymity, that isn’t possible, realistically. Even if it were, it wouldn’t be good for society. Cryptocurrency exchanges already have KYC (know-your-customer) obligations, and those obligations will likely get broader to ensure that people who use stablecoins for illegal purposes can be tracked down effectively.?

Capitalization requirements – Stablecoins currently function based on trust. Although some of the issuers have taken steps to provide some transparency (such as Tether’s publication of information about its collateral assets), the field is still self-regulated, and that’s unacceptable to central banks, and understandably so. As stablecoin usage continues to grow, fraud or mismanagement of the collateral assets could result in a catastrophic meltdown of not just the stablecoins involved, but also, potentially, the wider economy or at least sectors of it. Regulators will be looking to set guidelines regarding eligible collateral assets, their distribution, and the management processes.

Corporate Governance – At the moment, the companies that issue stablecoins operate in the same corporate governance category as any other private company. They generally do not have any special requirements like financial institutions do.??Regulations are likely to impact that area as well, as proper management of stablecoins becomes increasingly important for economic stability. Companies operating stablecoins can expect to see new qualifications for the membership of their boards of directors, mandatory inclusion of independent directors, the tenure of directors, the composition of their shareholders, among other possible regulations.?

Looking Forward

For now, stablecoins remain a viable option for remittances, although it’s not an option that’s available globally due to restrictions in various countries. That looks to be changing though. With more countries, multilateral development agencies, and financial institutions giving the nod to stablecoins, adoption is almost certain to continue rising.?

That rise will not be unchecked though and issuing companies as well as individual users must remain cautious. The rules can and will likely change at short notice when regulations take effect. To ensure that those regulations help and do not harm the remittances value proposition, it’s crucial that countries work hand-in-hand to formulate integrated policies. Failure to do so would mean stablecoins will devolve from the efficient solution they currently represent into a slow, costly option, bogged down by bureaucratic friction in the same manner as international wire transfers.?

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What do you think about stablecoins? Would you use them to transfer money internationally now? Why or why not? Please comment with your thoughts, subscribe to the newsletter, and share with others who would benefit.

Further Reading

European Central Bank - IN FOCUS I Issue no 3 I November 2019?Stablecoins – no coins, but are they stable????

Clifford Chance –?Stable Coins - A Global Overview of Regulatory Requirements in Asia Pacific, Europe, UAE and US

Mastercard:?Stablecoins: An FAQ On These Digital Assets

Brookings:?Regulating Stablecoins Isn’t Just About Avoiding Systemic Risk

International Monetary Fund:?Leveraging Digital Money to Facilitate Remittances